Federal Policies and the Medical Devices

Industry

November 1984

NTIS order #PB85-199552
Recommended Citation:

Federal Policies and the Medical Device Industry (Washington, D. C.: U.S. Congress, Office

of Technology Assessment, OTA-H-230, October 1984).

Library of Congress Catalog Card Number 84-601125

For sale by the Superintendent of Documents

U.S. Government Printing Office, Washington, D.C. 20402
Foreword

In recent decades, both the range of medical devices and the industry that manufactures them have greatly expanded. At the same time, there has been growing Federal

involvement in the U.S. health care system. The Medicare and Medicaid programs

established in the 1960s have increased the market for medical technologies and have

greatly influenced patterns of payment and use. The Federal Government instituted a

premarketing approval process for medical devices in 1976. Other activities, such as

funding research and development, regulating the providers of medical devices, and

providing medical care for veterans, have involved the Government in the development and purchase of medical devices.

Since the late 1970s, congressional committees have been interested in the effects

of such Federal policies on the companies that manufacture medical devices. In early

1982, this interest resulted in a request from the Senate Labor and Human Resources

Committee to the Office of Technology Assessment (OTA) for an assessment of Federal

policies and their effect on the medical devices industry. The Senate Veterans’ Affairs

Committee endorsed the request and expressed particular interest in the activities of

the Veterans Administration regarding device development and procurement.

In preparing this report, OTA staff drew upon the expertise of members of the advisory panel for the study, members of the OTA Health Program Advisory Committee, and experts in health policy, industry, research and development, economics, health

administration, and medicine. Drafts of the final report were reviewed by the advisory

panel, chaired by Dr. Richard R. Nelson; OTA’s Health Program Advisory Committee, chaired by Dr. Sidney S. Lee; and other individuals and groups with expertise in

the area. We are grateful for their assistance. Key OTA staff involved in the preparation of the document were Jane E. Sisk, Cynthia P. King, John C. Langenbrunner,

Katherine E. Locke, Lawrence H. Miike, and Judith L. Wagner.

U JOHN H. GIBBONS

Director

,.. Ill
Advisory Panel for Federal Policies and The Medical Devices Industry

Richard R. Nelson, Chair

Institute for Social and Policy Studies, Yale University

New Haven, CT

William F. Ballhaus

International Numatics, Inc.

Beverly Hills, CA

Ruth Farrisey

Massachusetts General Hospital

Boston, MA

Peter Barton Hutt

Covington & Burling

Washington, DC

Alan R. Kahn

Consultant

Cincinnati, OH

Grace Kraft

Kidney Foundation of the Upper Midwest

Cannon Falls, MN

Joyce Lashof

School of Public Health

University of California

Berkeley, CA

Penn Lupovich

Group Health Association

Washington, DC

Victor McCoy

Paralyzed Veterans of America

Washington, DC

Robert M. Moliter

Medical Systems Division

General Electric

Washington, DC

Louise B. Russell

The Brookings Institution

Washington, DC

Earl J. Saltzgiver

Foremost Contact Lens Service, Inc.

Salt Lake City, UT ●

Rosemary Stevens

Department of History and Sociology of Science

University of Pennsylvania

Philadelphia, PA

Allan R. Thieme

Amigo Sales, Inc.

Albuquerque, NM

Eric von Hippel

Sloan School

Massachusetts Institute of Technology

Cambridge, MA

Edwin C. Whitehead

Technicon Corp.

Tarrytown, NY
OTA Project Staff—Federal Policies and the Medical Devices Industry

Jane E. Sisk, Project Director

Cynthia P. King, Analyst

John C. Langenbrunner, Analyst 1

Katherine E. Locke, Research Assistant

Lawrence H. Miike, Senior Associate

Elaine J. Power, Intern2

Judith L. Wagner, Senior Analyst

Kerry Britten Kemp, Health and Life Sciences Division Editor

Virginia Cwalina, Administrative Assistant

Rebecca I. Erickson, Secretary/Word Processing Specialist

Brenda B. Miller, Word Processor/P. C. Specialist

Clyde J. Behney, Health Program Manager

Roger C. Herdman3 and H. David Banta,4 Assistant Director, OTA

Health and Life Sciences Division

Contractors

James R. Barth and Joseph J. Cordes, George Washington University

Dennis J. Cotter, Georgetown University Health Policy Center

Pony M. Ehrenhaft, Washington, DC

Hope S. Foster, O’Connor & Hannan, Washington, DC

John Hutton, University of York, England

IMS America Ltd., Rockville, MD

Kaye, Scholer, Fierman, Hays & Handler, Washington, DC

Kornmeier, McCarthy, Lepon & Harris, Washington, DC

Anthony A. Romeo, University of Connecticut

1Until November 1983.

2

Summer 1983.

3

From December 1983.

4Until August 1983.

v
Contents

Chapter Page

1.

2.

3.

4.

5.

6.

7.

Introduction and Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

Characteristics of the Medical Devices Industry. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Payment Policies for Health Care and Medical Devices . . . . . . . . . . . . . . . . . . . . . . . 41

Research and Development Policies Related to Medical Devices . . . . . . . . . . . . . . . 77

Regulation of Medical Devices by the Food and Drug Administration . . . . . . . . . . 97

Regulation of the Providers of Medical Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

Veterans Administration Policies Regarding Medical Devices . . . . . . . . . . . . . . . . . . 157

Appendixes Page

A.

B.

c.

D.

E.

F.

G.

H.

I.

J

Method of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179

Acknowledgments and Health Program Advisory Committee . . . . . . . . . . . . . . . . . 182

The Innovative Process in the Medical Devices Field . . . . . . . . . . . . . . . . . . . . . . . . . 186

Patent Policy Regarding Medical Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 191

Method Used for OTA’s Analysis of Applications to the National Institutes

of Health for Small Business Innovation Research Grants . . . . . . . . . . . . . . . . . . . . 196

The Database of Venture Economics, Inc., on Sources

of Financial Capital . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 197

Tax Policy and Research and Development on Medical Devices . . . . . . . . . . . . . . . 199

Consensus Standards Related to International Trade in Medical Devices . . . . . . . 204

Governmental Regulation of International Trade in Medical Devices:

United States, Canada, Japan, United Kingdom, France,

Federal Republic of Germany, and Mexico . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 216

Glossary of Acronyms and Terms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 231

References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 237

Index . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 257
1.

Introduction and Summary

No one has yet managed to measure the state of technical knowledge,

much less the rate of change of technological knowledge.

—M. Blaug
Contents

Introduction and Summary . . . . . . . . . . . . . . . . . . . . . . . .

Scope of the Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..................

Summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Payment Policies for Health Care and Medical Devices . . . . . . . . . . . . . . . . . . . .

Regulation of

R&D Policies

Regulation of

Medical Devices by the Food and Drug Administration . . . . . . .

Related to Medical Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . .

the Providers of Medical Devices. . . . . . . . . . . . . . . . . . . . . . . .

Veterans Administration Policies Regarding Medical Devices . . . . . . . . . . . . . . .

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

3

4

5

6

8

11

11

13

14
1. ■

Introduction and Summary

Medical devices are a striking feature of U.S.

medical care. The past generation has seen the development of a tremendous range of devices whose

use has improved or prolonged people’s lives and

revolutionized medical practice.

Some medical devices have enabled people with

what would otherwise be debilitating conditions

to improve their functioning. Artificial hip joints,

for example, have enabled elderly people with

crippling disabilities to walk and live independently. Other devices have extended people’s lives.

The Scribner shunt has permitted long-term hemodialysis for end-stage renal disease, and the cardiac pacemaker has controlled certain arrhythmias

of the heart.

Still other devices have drastically altered medical diagnosis and treatment. Starting with automated blood chemistry analyzers, clinical laboratories have shifted from manual to mechanized

procedures, with consequent improvements in the

speed, accuracy, and per-unit cost of tests. New

imaging devices, such as the computed tomography (CT) scanner, ultrasound, and mammography,

often obviate the use of more dangerous, painful, and costly procedures, such as exploratory

surgery. Innovations in needles, sutures, and microscopes have greatly improved cataract surgery.

The industry that manufactures medical devices

in the United States has grown in tandem with

these developments. From less than $1 billion in

1958, industry sales grew to more than $17 billion in 1983. Even after adjustment for inflation,

industry sales increased sixfold during that period.

About 3,500 companies now employ more than

200,000 people, compared with about 65,000

employees in 1958.

These changes in the medical devices industry

have occurred during an era of growing Federal

involvement in the U.S. health care system. The

Medicare and Medicaid programs, which were

enacted in 1965, have greatly increased health insurance coverage, expanded the market for medical devices, and influenced their development and

use. Between 1960 and 1982, primarily because

of the growth in Federal programs, the share of

medical expenditures paid by third parties rose

from 45 to almost 70 percent.

The kind of health insurance coverage that has

evolved in this country has insulated the buyers

and users of medical technologies—mainly physicians, hospitals, and patients—from the cost of

many medical services, especially those provided

in hospitals. The purpose of health insurance programs such as Medicare is to permit people to obtain needed medical care without risking financial ruin. But there is discretion involved in the

use of medical technology, and for many devices,

insurance coverage has reduced the importance

of cost as one of the few factors that motivate

discretion. Some devices, especially those associated with prevention and rehabilitation, are less

likely to be covered by insurance than others and

may be relatively underused.

The Medical Device Amendments of 1976 significantly expanded the Food and Drug Administration’s (FDA) authority to regulate medical

devices for safety and efficacy. This and other

Federal activities, such as supporting research and

development (R&D), regulating the purchase and

use of devices by medical providers, and delivering medical care to veterans, have substantially

involved the Government in the market for medical devices.

Congressional committees have been interested

since the late 1970s in the effect of Federal policies on the companies that manufacture medical

devices. There has been particular concern that

the newly established Federal regulatory process

for devices might be harming technological innovation and small companies. In early 1982, this

interest resulted in a request from the Senate Labor and Human Resources Committee to the Office of Technology Assessment (OTA) for an

assessment of Federal policies and their effect on

the medical devices industry. The Senate Committee on Veterans’ Affairs, in endorsing that

request, raised issues related to the Veterans Administration (VA) and its role in technology development and procurement. This report has been

prepared in response to those requests.

3
4 ● Federal Policies and the Medical Devices Industry

— .

SCOPE OF THE STUDY

Medical devices span a vast array of supplies

and equipment, from frequently purchased items

with low unit cost, such as bandages and syringes,

to infrequently purchased items with high unit

costs, such as clinical laboratory and imaging

equipment. The definition of a medical device

used for this study is taken from the 1976 Medical Device Amendments (Public Law 94-295) to

the Federal Food, Drug, and Cosmetic Act. Thus,

the term medical device refers to any instrument,

apparatus, or similar or related article that is intended to prevent, diagnose, mitigate, or treat disease or to affect the structure or function of the

body. This definition excludes drugs, which achieve

their effects through chemical action within or on

the body. Medical devices are thus one class of

medical technology as defined by OTA.l

A wide range of Federal policies helps to frame

the social, political, and economic context of the

market for medical devices. This report concentrates on Federal policies that have the greatest

leverage over the kinds of medical devices produced and the price at which they are sold: policies pertaining to payment for health care, support for R&D, regulation of the safety and efficacy

of medical devices by FDA, regulation of medical providers, and development and procurement

of devices by the VA. Policies that extend to the

entire economy, such as those regarding taxation,

financial capital, patents, and export control, are

excluded from detailed analysis. Although these

broader policies may affect medical devices, any

options for changing them would require an analysis that reached well beyond the confines of the

medical devices industry or this report.

As background to an analysis of Federal policies regarding the medical devices industry, it is

important to note that medical care differs from

many other products that are bought and sold.

Patients often do not have the expertise to evaluate

medical technologies and therefore tend to rely

on medical professionals for guidance concerning which medical services and devices to use.

IOTA has defined medical technology to include drugs, devices,

medical and surgical procedures, and the organizational and supportive systems within which medical care is provided.

Photo credit: E. /. du Pont de Nemours & Co.

Medical devices encompass abroad range of products,

including not only sophisticated, expensive equipment

such as computed tomography (CT) scanners, but

relatively simple and inexpensive items, such as

bandages, syringes, and stethoscopes.

Even medical professionals, however, often lack

the expertise to assess sophisticated devices, a fact

that underlies the regulatory process established

by the 1976 Medical Device Amendments.

Governmental programs such as Medicare reflect the social concern that people be able to obtain some minimum level of care, regardless of

their ability to pay. Benefits from the use of some

medical devices and other technologies, especially

those to prevent and treat infectious disease, include increases in overall levels of health and productivity and are thus greater for society than for

the individuals who use the technologies. Governmental public health programs to immunize

young children and to test their vision reflect the

societal importance attached to the use of such

medical technologies.

The remainder of this chapter summarizes the

chapters in the body of the report: characteristics of the medical devices industry, payment pol-
Ch. 1—Introduction and Summary ● 5

——-———- — — —

icies for health care and devices, FDA regulation

of devices, R&D policies related to devices, regulation of providers, and VA policies regarding

devices. Appendix A describes the method of conducting the study, and appendix B acknowledges

the valuable assistance of several individuals. Appendixes C through I contain material on topics

that relate to but are broader than medical deSUMMARY

In recent years, a number of problems have

been perceived in the cost, efficiency, quality, and

innovation of medical devices, all of which relate

in some way to Federal health care policies. Since

1978, U.S. expenditures for medical care have

been rising at an annual rate of 13 to 16 percent,

much faster than the rate of growth in the U.S.

gross national product. Although studies have not

documented the precise role of medical technology in escalating medical care costs,2 the adoption of new, sophisticated medical devices, such

as CT scanners, and overuse of existing devices,

such as automated clinical laboratory analyzers,

have often been implicated as contributing factors.

In addition to concerns about the growth or

level of health care expenditures, there is concern

about whether the benefits gained in improved

health or reduced worry have been worth the

costs. This concern stems from the prevalence of

health insurance, which has changed the balance

between costs and benefits for people who buy

and use medical technologies. Health insurance,

especially Federal programs, was originally intended to make basic medical care accessible to

people who might otherwise not be able to pay

for it. But recent concerns about costs have muted

such distributional issues. And some cost-effective

interventions that are not well covered by insurance, especially in preventive and rehabilitative

care, are probably underused.

Issues more directly related to medical devices

pertain to the quality of products marketed and

used, including their safety and efficacy, and to

‘See OTA’s report Medical Technology and Costs of the Medicare Program (342) for estimates of technology’s aggregate contribution to health, hospital, and Medicare costs.

vices: innovative activity, patent policy, tax policy, consensus standards in international trade,

and foreign regulation of international trade. In

addition to this main report, six case studies of

specific devices, a technical memorandum on the

policies of the VA, and a compilation of inventors’ vignettes are being published in connection

with this assessment.

continued innovation in the field. Concerns raised

in the early 1970s about fraudulent and hazardous devices culminated in the 1976 Medical Device Amendments to the Food, Drug, and Cosmetic Act. The regulatory process for devices

under this act, in turn, has led to concerns about

whether such regulation will impede innovation,

which has long been a hallmark of the medical

devices field, and whether the degree of consumer

protection gained is worth the costs.

The Federal policies most prominent and probably most influential in the medical devices field

have been those pertaining to health insurance

programs, chiefly Medicare and Medicaid, and

regulation of marketing. As discussed in this report, however, policies pertaining to R&D, regulation of providers, and veterans have had a

substantial role as well.

Federal funding of R&D has been a longstanding Federal activity, mainly within the purview

of the National Institutes of Health (NIH). Federal R&D in medical devices, as in other fields,

has been intended to stimulate worthwhile innovations that private developers might not otherwise undertake.

Federal and State regulation of providers who

purchase and use devices was an early response

to rising medical expenditures. Such regulation

has had two goals in addition to cost containment:

ensuring that people receive care of acceptable

quality and ensuring that the distribution of facilities is equitable.

The Federal Government has sought for many

years to ensure that veterans have access to medical care, including devices. In carrying out its
6 ● Federal Policies and the Medical Devices Industry

mandate, the VA has been involved in the full

range of activities from R&D through purchase

of devices. Because of the many VA medical

centers and individual veterans who rely on the

agency for devices, the VA has substantial leverage in the market for many devices.

The Federal policies just mentioned are frequently inconsistent, as one would expect of programs that have different, often conflicting, goals:

ensuring access to medical care for veterans,

elderly and poor people; containing the cost of

that care; ensuring acceptable quality of care; protecting public health and safety; stimulating worthwhile innovations; and minimizing the adverse effects of regulation on manufacturers. This report

and the remainder of this summary chapter describe and analyze these policies with respect to

their effect on the medical devices industry.

A thorough grounding in current and recent

Federal policies is particularly important for

assessing policy changes that are contemplated or

under way. In the area of payment for medical

care, tremendous changes are under way that may

affect devices. Medicare and some private thirdparty payers are beginning to pay hospitals a fixed

amount set in advance for each case.3 The adoption of this type of prospective payment method

for hospitals may substantially change the market for medical devices and may have implications

for the international trade position of U.S. manufacturers. In the process of implementing the new

payment system, Medicare is developing policies

that will affect medical devices, such as how to

pay for capital expenditures and how to ensure

use of care that conforms to an acceptable level

of quality.

Another important policy area is FDA regulation of medical devices and the balance between

protecting the public’s health and minimizing the

regulatory burden on manufacturers. Major portions of the Medical Device Amendments have yet

to be implemented, and implementation of some

may not be feasible.

3

See OTA’s technical memorandum Diagnosis Related Groups

(DRGs) and the Medicare Program: Implications for Medical Technology (341).

Payment Policies for Health Care

and Medical Devices

In general, health insurance has stimulated the

medical devices field by providing a secure and

growing market for the products used in medical

care. The effects of insurance on the market for

specific devices have varied, depending on the

coverage of the devices as benefits, the methods

of payment for covered devices, and the financial relationship between the payer and provider

of care.

In recent decades, the sales of devices whose

use has been well covered by insurance, such as

X-ray and electromedical equipment and surgical equipment and supplies, have grown much

more rapidly than sales of devices such as dental

supplies and ophthalmic goods, for which patients

pay a much greater share of the cost. Medicare

and most other health insurance programs cover

inpatient hospital care more fully than care provided in other locations, such as physicians’ offices and ambulatory laboratories. Some kinds of

medical care and their associated devices, such as

preventive technologies, eyeglasses, and hearing

aids, are excluded from coverage or covered to

a very limited extent.

Most methods of third-party payment for medical care used in the past have encouraged the

adoption and use of medical devices because providers have received more payment with greater

use of technology. Physicians and clinical laboratories have been paid by Medicare, some Medicaid, and many Blue Cross/Blue Shield plans for

the charges they have billed, subject to limits set

according to the fee levels prevailing in the area.

Besides stimulating use of technology, these chargebased payment methods have encouraged price

increases because insurers have used recently

billed charges to set new levels of payment.

Hospitals have traditionally been paid according to the charges they have billed or the costs

they have incurred. Traditional hospital payment

methods have encouraged the adoption and use

of medical technologies and have discouraged

price or cost containment.

Recently, however, Medicare and some States

have begun to pay hospitals prospectively (i.e.,
Ch. 1—Introduction and Summary ● 7

with rates set in advance of the time when they

apply). In October 1983, Medicare started to pay

hospitals a fixed amount per admission that varies

across 470 different diagnosis related groups

(DRGs). The amount now covers only inpatient

operating costs; capital, outpatient, and teaching

expenses are continuing to be paid on a cost basis

for the time being.

Medicare’s DRG payment system provides incentives for hospitals to become much more cost

conscious in their adoption and use of medical

devices and other resources. Whereas hospital

payment methods in the past have encouraged

providers and manufacturers to emphasize nonprice factors, DRG payment encourages them to

give more prominence to price considerations.

Especially favored by DRG hospital payment are

devices that lower the cost of a hospital stay by

reducing the costs of services provided or by

shortening the length of stay. Hospitals are likely

to increase group purchasing, standardize their

purchases, and require competitive bidding for

equipment and supplies.

How DRG rates are changed in future years to

reflect changes in prices and technology will affect incentives to develop and use new devices.

As payment incentives change, many U.S. device

manufacturers will face an adjustment in their

product development and marketing strategies,

from stressing quality to placing more emphasis

on price. However, such a change promises to

make U.S. devices more competitive internationally if U.S. companies can more effectively

challenge foreign ones on the basis of price as well

as technology.

The exclusion of capital expenses from the DRG

hospital payment rate fosters the adoption of

durable equipment and facilities relative to more

labor-intensive services, with inadequate regard

for the total benefits and costs of each. Congress

has stated its intention of including capital in the

prospective rate by 1986. Another problem is that

because Medicare’s DRG payment system applies

only to operating costs for inpatient care, it encourages the adoption and use of devices and

other resources in settings such as home health

care and hospital outpatient facilities, where DRG

payment is not in effect. In some cases, such as

surgery for cataract removal and placement of an

intraocular lens, it is possible that the movement

away from inpatient care may reduce cost and

benefit the patient. But DRG payment as now

established fosters changes in that direction with

inadequate regard for the effects on total costs of

care or benefits to patients.

Policy options can address these problems in

specific areas of medical care and device use. One

approach would be to develop payment methods

with financial incentives that are more neutral

with respect to physicians’ decisions to use devices

and that encourage physicians to select the least

costly settings of use. Currently, for example,

physicians have financial incentives to order and

perform clinical laboratory tests in their offices

Photo credit: E. I. du Pont de Nemours & Co.

Automated clinical chemistry analyzers, first developed

in the 1950s, improve the speed and accuracy and

lower the per-unit costs of laboratory tests on blood

samples. Their use, however, has been implicated as

a source of rising medical expenditures,
8 ● Federal Policies and the Medical Devices Industry

and to use procedures associated with new devices

for which high fees may be set. Congress could

require Medicare to experiment with payment

methods for laboratory and physician services

that are mindful of incentives regarding the use

of different technologies and locations of care.

Congress could also encourage Medicare to experiment with alternatives to reasonable charge

reimbursement of durable medical equipment and

to unify payment policies regarding parenteral or

enteral nutrition therapy for patients receiving and

not receiving home health services. Congress

might also consider including capital in Medicare’s

DRG hospital payment rates, so that hospitals

consider the cost of equipment and facilities when

making decisions about resources to purchase and

use.

The above options that address problems in

specific areas of medical care and device use

would continue payment methods with basic

shortcomings. These methods encourage the use

of medical technologies, including devices, because providers are paid more for using more services, and encourage technology use to shift to less

restricted, more lucrative locations. The resulting

pattern of use of devices and other technologies

is unlikely to reflect their relative costs and benefits. A different policy approach would be to

move Medicare in the direction begun with DRG

payment. Congress could encourage Medicare to

set overall limits on the amount to be paid for care

and to permit providers and patients to determine

the use of specific devices and other technologies

within that limit. Such methods of per-case or perperson payment could be applied to physician

services, all hospital care, or the full range of medical care.

Regulation of Medical Devices by the

Food and Drug Administration

FDA regulation of medical devices was intended

to protect consumers’ health and safety by ensuring that marketed products are effective and safe.

The Medical Device Amendments of 1976 provided more effective methods for dealing with

fraudulent devices and attempted to anticipate and

minimize the potential risks associated with increasingly sophisticated devices. Congress also intended that the regulation impede innovation in

the field as little as possible.

The Medical Device Amendments provided for

regulation according to the degree of potential risk

posed by a device. Devices that had been marketed before 1976 were to be assigned to one of

three classes: Class I, encompassing devices for

which general controls such as good manufacturing practices were deemed adequate to ensure

safety and efficacy; Class II, an intermediate category, for devices for which general controls were

deemed insufficient to ensure safety and efficacy

and for which performance standards could be developed; and Class III, for devices that support

life, prevent health impairment, or present an

unreasonable risk of illness or injury and require

FDA approval before marketing.

With limited resources, FDA has set priorities

in implementing the 1976 Medical Device Amendments. By early 1984, while the majority of the

medical specialty classification panels set up by

FDA had completed classification of the device

types4 assigned to them, the others had only proposed classifications. Twenty-seven percent of the

device types are in Class I; 64 percent are in Class

II; and 8 percent are in Class III.

To obtain FDA’s market approval, all Class 111

devices are required to show evidence of safety

and effectiveness. However, preamendments Class

III devices were given a 30-month grace period

before FDA could require such evidence, and FDA

may extend that period. Furthermore, until evidence is required for their preamendments equivalents, postamendments devices found “substantially equivalent” to Class III preamendments

devices may be marketed without additional proof

of safety and effectiveness.

FDA could have expedited the classification of

potentially high-risk Class III device types within

each medical specialty category, thereby starting

the grace period after which evaluation of Class

— — —

4A device type may include all products of a particular type (e. g.,

cardiac pacemakers) or grouping of devices that are similar (e.g.,

obstetrics-gynecology specialized manual instruments).
Ch. 1—Introduction and Summary ● 9

III preamendments devices of these types could

begin. Instead, FDA has completed classifications

of device types in the medical specialty categories in which most of the device-associated deaths

and injuries have been and continue to be reported—e.g., cardiovascular (pacemakers, heart

valves) and obstetrics-gynecology (intrauterine

devices (IUDs)). Furthermore, in September 1983,

FDA expressed its intention of reviewing evidence

of safety and effectiveness for 13 preamendments

Class III device types that it considers of highest

priority. Documentation of safety and effectiveness of products of these types will be needed for

their continued marketing.

Another of FDA’s priorities has been to implement the premarket approval process for postamendments Class III devices. Guidelines for the

procedures by which investigational Class III

devices may be tested and evidence gathered had

been completed by FDA by 1980.

FDA’s premarket approval process has been applied to only a small fraction of the devices marketed after 1976. Postamendments devices that are

found substantially equivalent to a device already

on the market are automatically classified and regulated like their preamendments equivalent. By

the end of fiscal year 1981, only about 300 of the

17,000 products submitted for clearance to FDA

after 1976 had been found not substantially

equivalent. Although products that are not substantially equivalent are automatically placed in

Class III, the manufacturer can petition FDA for

reclassification, and some manufacturers have

done this. *

No performance standards have yet been developed for Class II devices. In practice, therefore, Class II devices have been regulated like

Class I devices. In mid-1983, FDA identified 11

priority Class II device types for which it was

starting to develop the first performance standards. There is a consensus among industry and

consumers that although an intermediate class of

devices is advisable, it is impractical for FDA

to formulate performance standards for the

more than 1,000 device types now designated as

Class II.

Other examples of how FDA has set priorities

in implementing the Medical Device Amendments

can be cited. In 1980, for example, FDA exempted

30 Class I device types in the General Hospital

and Personal Use category from the requirement

that their manufacturers notify FDA before marketing them. The manufacturers of these device

types, which include medical absorbent fibers and

specimen containers not represented to be sterile, continue to be subject to FDA registration and

surveillance for conformity with good manufacturing practices regarding manufacture, packing,

and storage.

Substantial negative effects of the 1976 Medical Device Amendments on the medical devices

industry have not been documented to date. Perhaps this result is not surprising, because major

sections of the law have not been fully implemented. Patents on medical devices, one indicator

of innovative activity, have shown the same

trends as before the law, with a higher rate of

awards continuing for more sophisticated devices.

Manufacturers have reported increases in R&D,

sales, and new devices introduced since the Medical Device Amendments, and national data bear

out these reports. One-third of the manufacturers

responding to a national survey in 1981 had entered

the industry after the amendments, and 80 percent were optimistic about business in the field

during the next decade. Surprisingly, however,

almost half of the survey respondents stated that

Federal regulation had been a major problem for

them.

The regulations have been more burdensome

to small manufacturers than to large ones; smaller

manufacturers reported higher regulatory costs

per employee than larger ones. Small establishments are particularly important in the medical

devices field: about 70 percent of all establishments have fewer than 20 employees, and these

small establishments have historically accounted

for substantial innovation. The law expressed particular concern about small manufacturers by requiring that FDA establish an office to provide

them information. Although large manufacturers

in the 1981 survey were much more likely to consider producing a Class 111 device, it is noteworthy

25-406 0 - 84 - 2
10 ● Federal Policies and the Medical Devices Industry

that this situation existed before the amendments

as well. Thus, regulation may intensify this pattern but did not originate it.

The amendments have posed the greatest problem for small manufacturers of contact lenses. Because some contact lenses were regulated as drugs

before 1976, the newer types of lenses were automatically placed into Class III. Over the years,

small manufacturers have found it difficult to enter the market because of the expense of gathering clinical evidence on safety and effectiveness.

The public policy goals at odds in this case are

preserving the confidentiality of information from

manufacturers who have already received approval to market their devices versus increasing

the availability of products, with price competition as one result.

Available information does not permit an

assessment of consumer protection under the

Medical Device Amendments. Although the primary goal of the amendments is to protect public health and safety, there exists no systematic

information on the extent to which problems of

safety and effectiveness are occurring. Without

such information, one cannot assess the effect of

FDA’s choice of priorities in implementing the

law. Information from FDA’s present voluntary

system of reporting device hazards and from product recalls is inadequate, because it does not indicate the magnitude or frequency of devicerelated problems. Voluntary reports and recalls

for high risks have mostly involved implantable

devices, often with electrical problems, and cardiovascular devices. Since 1980, FDA has proposed several approaches to mandatory reporting

by manufacturers and expects to issue a revised

proposal in 1984.

Congress has several options to improve FDA’s

regulation of medical devices. Insofar as an overall

regulatory approach is concerned, Congress could

continue the basic framework and intent of the

1976 law and adjust specific provisions to reflect

judgments on the appropriate balance between

methods of ensuring safety and effectiveness and

the costs of these methods. An alternative strategy would be to revise the law to reflect the status

quo with regard to FDA’s implementation of the

law. A third approach would be to revise the law

to exclude certain device types from regulation

on the basis of their potential risk.

To address the issue of what evidence of safety

and effectiveness should be required for preamendments Class 111 devices, Congress could continue

FDA’s emphasis on high-priority device types,

limit requirements for evidence of safety and effectiveness to device types identified as problems,

or encourage FDA to accept a greater range of

evidence. To address the issue of when the evidence should be required, Congress could allow

FDA to continue its interpretation that the end

of the grace period is the earliest date that FDA

can require evidence, or could establish the end

of the grace period as the date when FDA must

call for evidence. Other congressional options pertain to possible revisions in the substantial equivalence method of market entry for postamendments devices.

There is widespread agreement that performance standards cannot be developed in a timely

fashion for all of the devices types that have been

placed in Class II. Congress could authorize FDA

to use other methods, such as voluntary standards or designation of prescription devices, to regulate Class II devices. Other options include legislating an additional category of Class II devices

with different requirements or reclassifying most

existing Class II device types into other classes.

Information on risks associated with medical

devices is crucial to assessing the 1976 law and

its effectiveness in consumer protection. Congress

could require FDA to develop better systems for

monitoring and providing information on device

risks or encourage FDA to selectively apply postmarketing controls to regulate Class II devices.

To help manufacturers, especially small ones,

through the regulatory process, Congress could

encourage FDA to use publicly available information to down-classify Class 111 devices as soon

as possible. FDA might also act as a broker between small firms with promising devices and clinical investigations capable of gathering data to

support premarket approval for Class 111 devices.
Ch. 1—Introduction and Summary ● 1 1

.———— . —--——- ——-

R&D Policies Related to Medical Devices

The present level of private R&D for medical

devices appears to be generally adequate. If industrial R&D in medical devices responds to market opportunities, as it does in other fields, the

greater demand for most medical devices because

of health insurance would argue that medical

devices R&D has been adequately stimulated.

From 1974 to 1980, R&D grew at an average

annual rate of about 16 percent in medical devices

companies, as compared with a rate of about 12

percent in industry as a whole. In 1980, company-sponsored R&D as a percentage of sales was

greater in medical devices than in industry as a

whole (2.9 percent compared with 1.6 percent).

The percentage of company-sponsored R&D

devoted to basic research differed only slightly in

medical devices firms and in industry as a whole

(3.7 percent compared with 4.1 percent).

Basic research has long been recognized as subject to underfunding by private companies. As research becomes more targeted to development of

a commercializable device, however, the case for

governmental involvement declines. Federal support has been lower for R&D conducted in medical devices companies than for industrial R&D as

a whole. In 1980, the Federal Government funded

less than 3 percent of the R&D conducted by medical devices firms, compared with 29 percent of

that conducted by industry as a whole.

Under a new Federal program, the Small Business Innovation Research (SBIR) program, NIH

and other Federal agencies with sizable R&D

budgets must set aside a small percentage for R&D

awards to small businesses. Although NIH funds

for the SBIR program may come at least partly

from funds that would otherwise have gone to

basic research and nonprofit institutions, the

redistributional implications of the program are

not yet clear. The program’s solicitation and selection methods merit attention as the funds devoted

to this effort increase.

The Orphan Drug Act of 1983 (Public Law 97-

414) charges the Federal Government to identify

and promote orphan products, including both

drugs and medical devices. Devices that are very

valuable to potential users, especially in relation

to their cost, and that are so costly that it would

be unreasonable or inequitable to expect potential users to pay a price sufficient to cover production costs, are by definition worthy of support. However, it is difficult to distinguish between

such orphan devices and devices that lack a sufficient market because they are not worthwhile.

Neither the Orphan Drug Act nor regulations

have provided sound criteria for identifying orphan devices. By spreading payment across many

people, third-party payment may render previous orphan devices and services affordable. Medicare coverage of dialysis for end-stage renal disease is an example. Expensive devices are usually

covered by health insurance, and many of those

not covered, including preventive and rehabilitative devices, may have a large enough market

to permit sale at a sufficiently low price. But the

problem of orphan devices may grow as third parties develop increasingly restrictive payment

policies.

The Orphan Drug Act makes available to orphan drugs certain benefits (e.g., grants and contracts for clinical testing) that are not available

to devices. It appears premature to extend the

benefits of the Orphan Drug Act to devices until

criteria are developed to distinguish orphan devices from those that are not worth their costs.

However, an option would be for Congress to

mandate that the Department of Health and Human

Services develop criteria and methods for identifying orphan devices.

Regulation of the Providers of

Medical Devices

Federal regulation of the providers of medical

devices applies mainly to facilities, such as hospitals, but affects physicians indirectly. Such regulation has been undertaken to promote good

quality medical care, to control rising costs by

evaluating technology adoption and use, and to

ensure access to care, including medical devices.

As a condition of receiving funds from Medicare, hospitals have periodically had to review the

medical necessity of admissions, extended stays,
72 ● Federal Policies and the Medical Devices Industry

— . ———.

and professional services. The reviews performed

by Professional Standards Review Organizations

(PSROs) focused more on reducing overutilization of inpatient care and on containing costs than

on reducing underuse or improving overall quality

of care. The emphasis of PSRO review was consistent with the incentives of Medicare’s cost-based

reimbursement system, which encouraged admissions and days and use of technologies even if

there were few benefits. The PSRO review program often led to reductions in admissions and

lengths of stay, but when the costs of the program

are taken into account, it is not clear that it saved

Medicare costs.

Under Medicare’s new DRG hospital payment

system, hospitals continue to have financial incentives to increase admissions, but they also have

incentives to reduce lengths of stay and technology use for inpatients. In order to be paid by

Medicare, participating hospitals are required to

contract by November 15, 1984, with utilization

and quality control peer review organizations

(PROS), which will monitor hospital admissions,

lengths of stay, and use of technologies. The focus

of the PRO review program has changed from

that of the PSRO program to reflect the incentives of the new payment system. Like PSROs,

PROS will review hospital admissions for overuse.

In addition, however, PROS must specifically

monitor cardiac pacemaker implantations and

reimplantations for possible overuse. PROS will

also be more concerned than PSROs were with

reviewing short lengths of stay and eventually

with underuse of ancillary services.

Medical devices have been most directly regulated through provider regulation by the State

certificate-of-need (CON) laws passed in response

to the National Health Planning and Resources

Development Act of 1974 (Public Law 93-641).

These regulations sought to reduce expensive

duplication of technology and to ensure access to

facilities. By 1983, all States except one (Louisiana)

had passed CON laws, but only 23 were in compliance with Federal requirements in 1984. Because

of uncertainty about the future of the Federal

health planning program, the current continuing

resolution stipulates that noncomplying States are

not to be penalized.

Photo credit: U.S. Veterans Administration

The VA Prosthetics Center was involved in developing

most of the prosthetic limbs and fitting techniques

used today.

Institutions such as hospitals, nursing homes,

kidney disease treatment centers, and ambulatory

surgical centers are required to obtain a CON

from a State or State planning agency for capital

expenditures that exceed a minimum threshold,

substantially change bed capacity, or substantially

change services. Medical research institutions and

health maintenance organizations (HMOs) are

given special consideration. Although State laws

may cover investments in other locations, only

nine States cover equipment purchases for physicians’ offices. Few devices have been expensive

enough to meet the threshold for CON review,

which is now $600,000 for capital expenditures,

$250,000 for annual operating costs from a change

in services, and $400,000 for major medical equipment. Under the higher limits that have been proposed, fewer devices would come under review.
Ch. 1—introduction and Summary ● 1 3

—

Evidence on the effect of CON laws on the

adoption of medical devices has been inconclusive. Early studies indicated that numbers of hospital beds fell, but investment and assets per bed,

which relate to devices, rose. This result is consistent with the CON emphasis on bed supply and

the high thresholds for review. There is no indication that CON has controlled medical costs. This

finding is not surprising, because a CON agency

has no limit on the annual capital expenditures

that it may approve and does not consider operating costs, total costs, or use of devices and other

technologies. The program was also charged with

often-conflicting goals of controlling cost and

assuring access, and relied on consensus among

decisionmakers with different interests. It is possible, however, that CON procedures may have

deterred applications and purchases.

The different incentives for hospitals under

DRG payment have implications for CON laws.

Some of the change depends on how capital expenses are handled under the DRG system. Under

DRG payment, hospitals themselves may increasingly have financial incentives to adopt costreducing devices and to examine carefully costraising ones. And DRG payment has strengthened

the incentive for providers to locate and use equipment and facilities outside of the more constrained

inpatient setting in such sites as ambulatory diagnostic centers or physician offices.

Several approaches could be taken to deal with

the shortcomings of the CON process. Congress

could expand the scope of CON regulation to

cover purchases of equipment in all locations, or

it could place a limit on the annual level of capital expenditures that CON agencies could approve. Alternatively, Congress could eliminate the

CON requirement from the National Health Planning Act.

Veterans Administration Policies

Regarding Medical Devices

With 172 medical centers, an annual budget of

about $1.3 billion for equipment and supplies, and

an R&D budget of almost $160 million, the VA

has the potential to exert substantial influence in

the market for medical devices, especially the market for rehabilitative devices.

Rehabilitation R&D in the VA is intended to

improve the quality of life and to further the independence of physically disabled veterans. The

program has stressed developing practical devices

and increasing the availability of new devices on

the market, especially in prosthetics, sensory aids,

and devices related to spinal cord injuries. In the

past, the VA Prosthetics Center was involved in

developing most of the prosthetic limbs and fitting techniques used today and in demonstrating

uses of electric wheelchairs, which were then

adopted by manufacturers. In recent years, funding has shifted toward intramural projects, such

as rehabilitation R&D centers, which are affiliated

with leading engineering schools. Adjusted for inflation, VA funds committed to R&D in rehabilitative devices have been stable or declining.

Responsibility for testing and evaluating medical devices is divided among several VA organizational units. Despite the opportunity that the VA

system presents to test devices under actual conditions of use, problems of coordination among

units and of adherence to evaluation protocols

have hampered field testing of rehabilitative devices at VA medical centers.

The Testing and Evaluation Staff in Hines, IL,

is responsible for testing nonrehabilitative devices,

mainly standard stock items and smaller medical

equipment. These evaluations, which are aimed

at validating manufacturers’ claims, consist mainly

of consumer research efforts. Although VA regulations prohibit explicit comparison of different

products, some evaluations of classes of devices

have been attempted. These evaluations are used

by purchasers of devices inside and outside of the

VA system.

Through the VA Marketing Center in Hines,

which manages and negotiates the VA’s national

purchasing contracts, the VA has a substantial

position in the markets for medical equipment and

supplies. Procurement by the VA Marketing Center has accounted for 5 to 10 percent of the national sales of X-ray, nuclear diagnostic, hemodialysis, and patient monitoring equipment. And

the VA has enhanced its market leverage by con-
14 ● Federal Policies and the Medical Devices Industry

tracting for the U.S. Public Health Service, the

Department of Defense, and other Government

agencies. The VA’s market power has allowed the

VA to obtain favorable prices on medical supplies

through its centralized procurement channels.

VA medical centers purchase about 34 percent

of their supplies through centralized procurement

programs run by the VA or the General Services

Administration. However, the medical centers

have increasingly made purchases on the open

market rather than through central supply channels, their open market purchases having risen

from 10 percent of total purchases in the early

1960s to 39 percent in 1982. The VA medical

centers’ reduced use of central purchasing prevents

the VA from taking advantage of lower prices

available through greater device standardization

and volume purchases.

The patterns of adoption and use of devices by

the VA health system are conflicting. Some types

of major medical equipment, such as CT scanners,

may have been adopted by the VA less than warranted because of political pressures to contain

costs. On the other hand, by statute, the provision of prosthetic devices to eligible veterans is

unlimited. The VA’s plan to set the budgets of

medical centers on the basis of DRGs may distribute funds more rationally. This DRG system

bears monitoring as it is implemented for issues

of quality assurance and treatment of capital expenses.

Congressional options to improve VA policies

towards medical devices could focus on specific

areas, such as increasing research for longer term

development of rehabilitative devices and expanding field testing of rehabilitative devices. Congress

could also require the VA to move in the direction of undertaking more comparative evaluations

of devices and increasing centralized procurement

to take advantage of lower prices.

Conclusions

Since the purpose of the Medical Device Amendments of 1976 is to protect public health and

safety, assessment of the law and potential changes

in the act or its implementation cannot proceed

without systematic information on the hazards

associated with device use. Such information is

now lacking. Available evidence indicates that the

medical devices industry has not been systematically affected by regulation of marketing by

FDA, insofar as companies have continued to be

profitable and innovative and to enter the field.

However, small manufacturers of contact lenses

have had particular problems.

The medical devices industry has responded to

incentives in the market, especially those from

payment policies. As a result, the market has generally rewarded attention to technological sophistication but not to price or cost-consciousness and

has fostered the development of devices used in

acute care rather than in prevention and rehabilitation. Medicare’s new method of paying hospitals on the basis of DRGs has the potential for

cost containment and efficiency by providing incentives for providers, and hence manufacturers,

to become more cost conscious.

At the same time, Medicare’s DRG payment

system raises important concerns: assurance of

quality of care when providers have a financial

incentive to minimize the use of technologies including devices, and possible inefficiencies if devices are purchased and used in locations less

financially constrained than hospitals. The appropriate role of the CON program is tied to how

capital expenses are handled under the DRG payment system. In any case, issues of access to

devices for low-income and sparsely populated

areas will remain. And as health insurance coverage and payment become more constrained, the

concept of orphan devices may require more

precise definition. The VA has the potential to use

its leverage in the market, especially for rehabilitative devices, to channel development and commercialization into orphan devices with substantial social need and worth.
2.

Characteristics of the

Medical Devices Industry

An initial invention, however dramatic, needs many refinements before it

is of widespread use. In the commercialisation of technology, the tortoises

who carry out these refinements often beat the hares.

—The Economist
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Growth in the Medical Devices Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17

Diversity in Products.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Characteristics of Medical Devices Manufacturers. . . . . . . . . . . . . . . . . . . . . . . . 25

Concentration in the Medical Devices Industry . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

Innovation in Medical Devices .............. . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

International Competitiveness of U.S. Medical Devices . . . . . . . . . . . . . . . . . . . . 35

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

LIST OF TABLES

Table No. Page

1. Current Dollar Value of Shipments of Medical Devices by SIC Code,

Selected Years 1958-83 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

2. Real (1972) Dollar Value of Shipments of Medical Devices

by SIC Code, Selected Years 1958-83 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

3. Growth in Medical Device Companies, Establishments, and Employment

by SIC Code, Selected Years 1963-82 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

4. Number of Employees in the Medical Devices Industry

by SIC Code, Selected Years 1958-83 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

5. Percent Return on Assets for Medical Devices and Selected Industries

by IRS Category, Selected Years 1963-80. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

6. Growth in the Output and Employment of Selected Industries, 1963-82 .,.. 22

7. Products in the Medical Devices Industry by SIC Code . . . . . . . . . . . . . . . . . . 23

8. Sales of Selected Medical Devices to Hospitals by SIC Code, 1982 . . . . . . . . 25

9. Medical Devices in an Internist’s Office . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

10. Size of Employment in Medical Devices Establishments

by SIC Code, 1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 27

11. Market Share of Value of Medical Devices Shipments

by Establishment Size, 1977, 1972, and 1963.. . . . . . . . . . . . . . . . . . . . . . . . . 27

12. Price-Cost Margins of Medical Devices Establishments

by Employee Size, 1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28

13. Market Share of Value of Medical Devices Shipments

by Leading Companies, 1977 and 1963.... . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

14, Leading Companies’ Market Share of Hospital Sales

of Medical Devices, 1982 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

15. Eight Leading Companies in Hospital Sales of Medical Devices in Three

or More Product Categories, 1982 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

16. U.S. and Foreign Medical Devices Patents Granted by U.S. Patent Office

by Application Date, 1968-79 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34

17. U.S. and Foreign Medical Devices Patents Granted by U.S. Patent Office

by Source and Selected Categories, 1968-79. . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

18. U.S. Exports and Imports of Medical Devices by SIC Code, 1979-83. . . . . . . 36
2.

Characteristics of the

Medical Devices Industry

INTRODUCTION

In recent decades, the industry that manufactures medical devices has experienced continuous

growth and change. As increased health insurance

coverage has expanded purchasing power for

medical care, the market for medical devices has

grown correspondingly. Growth has occurred not

only in the number of companies and employees

working in the field, but also in the range of products developed and marketed. Throughout all facets of medical care—from diagnostic imaging and

surgery to dentistry and optometry-devices unknown a generation or even a decade ago are now

part of routine practice.

This chapter presents the most notable features

of the medical devices industry. Besides the dy -

namic nature of the field, several themes emerge.

One is great diversity, both in the medical devices

that are marketed and in the companies that make

them. Underlying the diversity in products is the

high level of innovation. Another theme is that,

more than in many other U.S. industries, small

firms are particularly important in developing and

producing medical devices. U.S. medical devices

appear to be quite competitive internationally.

Despite the diversity in companies and products,

however, the concentration of production in medical devices is about the same as it is in a typical

industry, i.e., a relatively small number of companies account for a sizable share of the market.

GROWTH IN THE MEDICAL DEVICES INDUSTRY

During the past 25 years, sales (value of shipments) of products in the five Standard Industrial

Classification (SIC) codes representing medical

devices have grown from less than $1 billion to

more than $17 billion, an annual increase of more

than 12 percent (table 1). The growth has been

enormous, even when expressed in real dollars,

which are intended to take account of price changesl

(table 2). By 1982, sales in real dollars had reached

six times the 1958 level, having risen at an average annual rate of 8 percent.

Growth in sales appears to have accelerated

after 1963, a period which coincided with the early

years after implementation of the Medicare and

1Like most price indexes, those of the Department of Commerce

measure annual price changes in a market basket of devices that

were specified in 1972 (369). A common problem with such indexes

is their inability to take into account price changes associated with

the introduction of new products and with changes in product

quality. This problem is particularly acute for medical devices, which

have experienced constant and dramatic change.

Medicaid programs in 1966. From 1966 to 1982,

total U.S. expenditures on personal health care

in real dollars grew at an average annual rate of

5 percent, and those of the Medicare program

alone at 18.5 percent.

Although the start of Medicare and Medicaid

was the most notable change, both private and

public third parties have accounted for an increasing share of the growing expenditures on personal

health care—from 35 percent in 1950 (12 percent

private, 12 percent State and local, 10 percent Federal) to 51 percent in 1966 (25 percent private, 12

percent State and local, 13 percent Federal) and

69 percent in 1982 (28 percent private, 11 percent

State and local, 29 percent Federal) (128). Although the exact relationship has not been documented, growth in health care expenditures expanded the market for products such as medical

devices that are used in the course of delivering

that care (see ch. 3).

17
Table I.—Current Dollar Value of Shipments of Medical Devices by SIC Code, Selected Years 1958-83a

Current dollar value of shipments (in millions) Annual percentage changeb

X-ray and Surgical Surgical Dental

electro- and appliances equipment X-ray and Surgical Surgical Dental

medical medical and and Ophthalmic electro- and appliances equipment

equipment instruments supplies supplies goods medical medical and and Ophthalmic

Year (Sic 3693) (Sic 3841) (Sic 3842) (Sic 3843) (SIC 3851) Total equipment instruments supplies supplies goods Total

1983c . . . . $5,500 $4,590 $6,140 $1,180 N A

d

$17,410e 21% 12% 90/0 70/ 0 — 13%e

1982 . . . . . 4,557 4,114 5,642 1,107 $1,358 16,778 42 30 19 -16 8 23

1981 . . . . . 3,203 3,158 4,734 1,314 1,263 13,672 27 17 23 5 4 18

1980 . . . . . 2,527 2,697 3,861 1,252 1,212 11,549 10 14 14 17 8 13

1977 . . . . . 1,885 1,833 2,597 787 972 8,074 34 14 12 14 11 16

1972 ..., . 444 962 1,454 409 568 3,837

1967 . . . . .

14 15 12 13 6 12

233 475 838 221 426 2,193 13 14 9 11 12 11

1963. . 144 284 597 148 273 1,446 9 17 5 5 7 8

1958 . . . . . 95 130 462 116 194 997 – — — — — —

a

For a Iwtlng of products In the Standard industrial Classification (SIC) codes used, see table 7

‘For Inconsecutwe years, the compound annual growth rate, the annual rate of growth that makes the present value compound forward to equal a speclfled future value, was calculated.

‘AA = [( FVIPV)l IN – 1] 100, where O/OA = compound annual growth rate

FV = future value (the value at the end of N compounding periods)

PV = present value

N = total number of compounding periods

cPreliminary estimates.

dNA Indicates information not available.

‘Total does not include shipments of ophthalmic goods.

SOURCES: U.S. Department of Commerce, Bureau of Industrial Economics, Capital, Energy, and Productivity Studies Division, Washington, DC, unpublished data, January 1984; P. Marcus, U.S. Department of Commerce,

Washin ton, DC, personal communication, Janua

8

~ 1984; U.S. De partment of Commerce, Bureau of the Census, 7982 Census of kfamfacwres, Preliminary Report Industry Series, MC82-I-38F-3(P),

MC82-I- 8B-l(P), MC82-I-38B-2(P), MC82-I-38B-3(P), M 82-I-38 B-4(P), 1984; and E. Arakaki, U.S. Department of Commerce, Washington, DC, personal communication, August 1984.
Table 2.–Real (1972) Dollar Value of Shipments of Medical Devices by SIC Codea

, Selected Years 1958=83

Real (1972) dollar value of shipments (in millions) Annual percentage changeb

X-ray and Surgical Surgical Dental

electro- and appliances equipment X-ray and Surgical Surgical Dental

medical medical and and Ophthalmic electro- and appliances equipment

equipment instruments supplies supplies goods medical medical and and Ophthalmic

Year (SIC 3693) (sic 3841) (Sic 3842) (Sic 3843) (SIC 3851) Total equipment instruments supplies supplies goods Total

1983 C . . . . $2,145 $2,050 $2,975 $540 N A

d

$7,710’ 150% 70% 70% 20% 9%e

1982 . . . . . 1,858 1,915 2,790 528 $757 7,848 35 21 19 -20 8 18

1981 . . . . . 1,374 1,587 2,337 659 704 6,661 14 6 16 -4 -4 9

1980 . . . . . 1,210 1,494 2,007 685 735 6,131 -1.7 5 7 7 1 4

1977 . . . . . 1,274 1,273 1,649 564 707 5,467 23 6 3 7 4 7

1972 . . . . . 444 962 1,454 409 568 3,837 11 10 12 3 9

1967 . . . . . 311 568 920 234 479 2,512 9 11 7 10 11 9

1963. 217 377 705 160 312 1,771 8 15 5 4 6 7

1958 . . . . . 150 184 549 130 231 1,244 — — — — — —

a

For a listing of products in the SIC categories used, see table 7

“For inconsecutive years the compound annual growth rate, the annua! rate of growth that makes the present value compound forward to equal a specified future value. was calculated

0

/0 J = [( FVIPV)l ‘N – 1 ] 100 where O/OA = compound annual growth rate

FV = future value (the value at the end of N compounding periods)

PV = present value

N = total number of compounding periods

cPreiiminary estimates.

dNA indicates information not available.

‘Total does not include shipments of ophthalmic goods.

SOURCES: U.S Department of Commerce, Bureau of Industrial Economics, Capital, Energy, and Productivity Studies Division, Washin ton, DC, unpublished data, January 1984; P. Marcus, U.S. Department of Commerce,

Washington, DC, personal communication, January 1%34; M. Pavliscak, U.S. Department of Commerce, Washington, DC, persona communication, June f 19S4; and E. Arakakl, U.S. Department of Commerce, Washington,

DC, personal communication, August 19S4.
20 ● Federal Policies and the Medical Devices Industry

All segments of the medical devices industry

have benefited from this growth, some more than

others (tables 1 and 2). Most medical devices fall

into one of five SIC codes of the Department of

Commerce: 3693, X-ray, electromedical, and

electrotherapeutics equipment; 3841, surgical and

medical instruments; 3842, orthopedic, prosthetic,

and surgical appliances and supplies; 3843, dental equipment and supplies; and 3851, ophthalmic goods.2

2The most comprehensive statistics on the medical devices industry

come from the Census of Manufactures, which is conducted by the

Bureau of the Census in the Department of Commerce. The data

relate to domestic production by U.S. and foreign companies operating in the United States. A complete census is conducted every

5 years and an Annual Survey of a sample in intervening years. Products are categorized by Standard Industrial Classification (SIC) codes.

Establishments are assigned to SIC “industries” on the basis of their

primary line of business. A 1980 sample of 1,891 manufacturing

establishments registered with the Bureau of Medical Devices in the

Food and Drug Administration (FDA) fell into 162 SIC codes: 47

percent into the 5 major medical devices codes, which included an

average of 177 establishments per code; 37 percent into 25 other

SIC codes, each with 10 or more establishments; and 16 percent into

132 other SIC codes, each with fewer than 10 establishments (393).

It can therefore be inferred that the establishments in the five medical devices codes account for a greater volume of medical devices

production than those in other codes. Nevertheless, data by establishment from the five medical devices SIC codes exclude some

establishments and perhaps some devices of multiproduct establishments whose primary products fall into other categories.

In addition, the FDA sample lists 47 establishments in SIC 2831,

biological (393). Diagnostic substances and other biological represent about 45 percent of all shipments in SIC 2831 (363), but the

data are not sufficiently detailed to permit separation of these medical devices products from other biologics, such as blood and

vaccines.

SIC data on product shipments, however, include shipments of

all medical devices, both those produced by establishments classified

in the five medical devices codes and those classified in other codes

(393).

In both current and real dollars, sales of products in SIC codes 3693, 3841, and 3842 are much

greater than sales of dental equipment and supplies and ophthalmic goods. Not only are sales

in these three codes the largest in absolute terms,

but they have also experienced the highest rates

of increase, especially since 1980. SIC 3842 (surgical appliances and supplies), the category with

the greatest sales, has had the highest growth

rates, followed closely by SIC 3693 (X-ray, electromedical, and electrotherapeutics equipment).

The tremendous growth in SIC 3693 from 1972

to 1977 may be somewhat overstated; in 1977,

products misclassified in other SIC codes, mainly

3841, were assigned to 3693 (393).

Increases in the number of companies (firms)

and establishments (plants) have paralleled the increases in sales (see table 3). From 1963 to 1982,

SIC 3693 (X-ray and electromedical equipment),

with annual rates of about 7 and 8 percent respectively, experienced the greatest rate of increase in

companies and establishments. During this period,

the other four SIC codes had annual increases

ranging from about 2 to 6 percent. In all five medical devices codes, firms entering a field have thus

exceeded those exiting.

By 1982, employment in the establishments in

the SIC medical devices codes had exceeded

200,000, a 68-percent increase over the 129,500

employed in 1972 (see table 4). SIC 3693 (X-ray

and electromedical equipment) again had the

greatest rates of increase, reflecting the huge

growth in production and facilities during the

decade.

Table 3.–Growth in Medical Device Companies, Establishments, and Employment by SIC Codea, 1963-82

1982 levels (number) 1963-1982 compound annual growth rate

Employment

SIC industry segment Companies Establishments (thousands) Companies Establishments Employment

Total . . . . . . . . . . . . . . . . . . . . . . 2,986 3,361 217.5 4.4% 4.0% 5.6%

SIC 3693: X-ray and

electromedical

equipment . . . . . . . . . . . . . . . 205 260 49.2 7.1 8.2 11.5

SIC 3841: Surgical and

medical instruments . . . . . . 767 858 57.4 5.9 5.8 7.3

SIC 3842: Surgical appliances

and supplies . . . . . . . . . . . . . 1,212 1,365 68.6 4.5 3.5 4.8

SIC 3843: Dental equipment

and supplies . . . . . . . . . . . . . 435 474 15.4 2.6 2.2 3.5

SIC 3851: Ophthalmic

goods . . . . . . . . . . . . . . . . . . . 367 404 26.9 3.0 3.0 1.5

at=or a listing of products in the SIC categories used, see table 7.

SOURCES: U.S. Department of Commerce, Bureau of the Census, 1$%3 Census of Manufactures, Industry Series, MC63-I-36E and MC634-38A, 7982 Census of Marrufactures, Preliminary Report Industry Series (Washington, DC: U.S. Government Printing Office, 1966 and 1984).
Ch. 2—Characteristics of the Medical Devices Industry ● 2 1

Table 4.—Number of Employees in the Medical Devices Industry by SIC Codea,

Selected Years 1958.83 (in thousands)

X-ray and Surgical

—

Surgical Dental

elect ro- and appliances equipment

medical medical and and Ophthalmic

equipment instruments supplies supplies goods

Year (SIC 3693) (SIC 3841) (SIC 3842) (SIC 3843) (SIC 3851) Total

1983 b . . . . 50.5 62.0 71.2 16.2 N A

c

199.9d

1982 . . . . . . 49.2 57.4 68.6 15.4 26.9 217.5

1981 . . . . . . 41.5 54.6 64.9 17.4 26.4 204.8

1980 . . . . . . 38.8 51.3 61.8 16.7 29.4 198.0

1977 . . . . . . 30.9 43.2 53.9 16.3 30.0 174.3

1972, . . . . . 12.1 34.5 43.9 12.4 26.6 129.5

1967 ....., 7.9 22.0 35.2 10.2 25.6 100.9

1963 . . . . . . 6.2 15.1 28.3 8.0 20.3 77.9

1958 . . . . . . 5.3 10.3 24.2 7.2 18.2 65.2

aFor a listing of proctucts In the SIC categories used, see table 7

bPreliminary estimates.

CNA indicates information not available.

dTotal does not include employment in the ophthalmic goods Industry.

SOURCES: U.S. Department of Commerce, Bureau of the Census, Annual Survey of Manufactures, Statistics for Industry Groups

and Industries, for years 1958, 1983, 1987, 1972, 1977, and 1981; U S Department of Commerce, Bureau of Industrial

Economics, 1984 US. Industrial Outlook (Washington, DC U S Government Printing Office, January 1984); and

E Arakaki, Department of Commerce, Washington, DC, personal communication, August 1984.

In 1982, about 3,000 companies (firms) with

3,400 establishments (plants) were manufacturing products in the five medical devices SIC codes

(table 3). Although this information is the most

comprehensive and most recent available, it excludes multiproduct establishments with primary

products in other codes. Changes in employment

may be used as a proxy for changes in numbers

of companies and establishments. In 1980, 4,300

establishments were registered with the Food and

Drug Administration (FDA) as being engaged in

manufacturing medical devices (197).3

Available information from the Internal Revenue Service (IRS) indicates that the profit rates

of medical devices companies have exceeded those

of many other manufacturing industries (table 5).

The IRS category 3845 (optical, medical, and ophthalmic goods) includes some firms that do not

produce medical devices (optical instrument and

lenses firms) and excludes some that do (if their

principal line of business lies in a different category). Nevertheless, this category contains substantial numbers of firms whose principal activity is producing medical devices (26). Sales of

electrical medical devices may represent a small

fraction—perhaps at the most 10 percent—of IRS

category 3698 (other electrical equipment) (26).

3As explained in ch. 5, several entities besides medical devices manufacturers also register with FDA.

Annual profit rates for both of these IRS categories ranged from 10 to 18 percent (26), higher than

the 9 to 11 percent in total manufacturing. In

1980, firms in IRS category 3845 (optical, medical, and ophthalmic goods), with 12.7-percent return on assets, were more profitable than firms

in similar products such as other electrical equipment, chemicals and allied products, and electrical and electronic equipment.4

By any of these measures—sales, companies,

establishments, employment, or profits—the growth

of the medical devices industry has far exceeded

that of many other industries (table 6). For example, from 1963 to 1982, the output of the total

manufacturing sector grew at an annual rate of

2.7 percent and employment at a 0.5-percent rate.

Even chemicals and related products, electrical

and electronic equipment, and instruments and

related products—sectors with products similar

to medical devices—achieved much lower annual

increases in output (from 4.3 to 5.6 percent annually) and in employment (from 1.4 to 2.9 percent annually).

4According to data from Dun & Bradstreet, returns on assets (indicators of profits) for medical devices SIC codes have equaled or

exceeded returns on assets in other fields (95). For example, from

1978 to 1980, returns on assets for SIC 3693 (X-ray, electromedical, and electrotherapeutics devices) ranged from 8.8 to 11.4 percent,

compared with a range of 9.0 to 9.8 percent for the broader SIC

category 36 (electrical and electronic machinery, equipment, and

supplies )
22 . Federal Policies and the Medical Devices Industry

— —.—. .

Table 5.—Percent Return on Assetsa for Medical Devices

and Selected Industries by IRS Category, Selected Years 1963-80

Optical, medical Other Chemicals Electrical

and ophthalmic electrical Total and allied and electronic

goods b

equipment manufacturing products equipment

Year (IRS 3845) (IRS 3698) (IRS 40) (IRS 17) (IRS 25)

1980 . . . . . . 12.70/o 11 .0%0 10.50/0 11.29’0 9.6%

1977 . . . . . . 14.5 11.2 10.6 12.5 10.5

1972 . . . . . . 13.1 9.6 8.8 11.3 7.7

1967 . . . . . . 17.9 13.6 10.2 12.8 11.4

1963 . . . . . . 12.1 12.9 10.2 14,0 9.5

aPercent return on assets =

Net income (less deficit) + interest paid

Total assets

Net income (less deficit) equals “total receipts less total deductions” less “Interest on State and local Government obligations”

Ius “constructive taxable income from related forei n corporations:’

~he IRS minor industry 3845 (optical, medical and op%halmic goods) includes firms that would declassified in SICcategories

383 0 tical instruments and lenses), 364 (surgical, medical, and dental instruments and supplies), and 365 (ophthalmic goods).

cThe\F&minorindustry 3698 (other electrical equipment) includes firms that would declassified in SICcategories 361 (electric

transmission and distribution equipment), 362 (electrical industrial apparatus), 364 (electric lighting and wiring equipment), and

369 (miscellaneous electrical machinery, equipment, and supplies).

SOURCES: U.S. Department of the Treasury, Internal Revenue Service, Sourcebook of Statistics of hmorne, for years 1963, 1967,

1972, 1977, and 19~; Corporation Income T= Returns, statistics of income, for years 1963, 1967, 1972, 1977, and 1960;

A General Description of the Corporation Source Book, publication 647, revised June 1983.

Table 6.—Growth in the Output and Employment of

Selected Industries, 1963=82

1963-82 compound

annual growth rate

Industrial sector Output Employment

Total manufacturing . . . . . . 2.7% 0.5%

Chemicals and

allied products . . . . . . . . 4.3 1.4

Electrical and

electronic equipment . . . 5.6 1.5

Instruments and

related products . . . . . . . 5.6 2.9

SOURCES: U.S. Department of Commerce, Bureau of Industrial Economics, 1984

U.S. /ndustria/ Outlook (Washington, DC: U.S. Government Printing

Office, January 1984); and V. Kettering, U.S. Department of Commerce, Bureau of Industrial Economics, Washington, DC, personal

communication, February 1984.

DIVERSITY IN PRODUCTS

The devices included in the five major SIC

codes illustrate the wide range of products, not

only across codes but within each code as well

(table 7). SIC 3842 encompasses disposable supplies such as surgical drapes and adult diapers as

well as wheelchairs and prostheses. And together

the different codes include pacemakers, hospital

furniture, and materials for dentures.

Table 8 presents 1982 sales of selected medical

devices to U.S. hospitals. These data are national

estimates that IMS America, Ltd., has compiled

The Department of Commerce has ranked several of the medical devices SIC codes in the top

50 codes whose growth in 1984 is predicted to exceed their 1972-81 peak: 3842, orthopedic, prosthetic, and surgical appliances and supplies, as

9th; 3693, X-ray, electromedical, and electrotherapeutic equipment, as 11th; 3841, surgical and

medical instruments, as 13th; 2831, biological

products, as 24th; and 3843, dental equipment and

supplies, as 47th (369).

for OTA from the purchases of a sample of hospitals. Because the IMS data include only devices

that are purchased frequently enough to permit

statistical estimation, many expensive devices that

are rarely purchased by individual hospitals, such

as computed tomography (CT) scanners, do not

appear.

Almost half of personal health care expenditures in the United States relate to hospital care

(128), and hospitals-use devices more intensively

than other health care settings. Thus, the data in

table 8 give some indication of the size of the mar-
Ch. 2—Characteristics of the Medical Devices Industry ● 2 3

Table 7.—Products in the Medical Devices Industry by SIC Codea

SIC code/products SIC code/products

3693—X-ray, electromedical, and electrotherapeutics

apparatus

Irradiation (ionizing radiation) equipment, including X-ray,

beta ray, gamma ray, and nuclear (medical, dental,

industrial, and scientific)

Medical X-ray equipment:

Diagnostic

Therapeutic

Dental X-ray equipment

Industrial and scientific X-ray equipment, excluding

gamma and beta ray equipment

X-ray equipment accessories

X-ray tubes (sold separately)

Parts for X-ray equipment (sold separately)

All other ionizing radiation equipment, including

gamma and beta ray equipment, excluding

accelerators, cyclotrons, etc.

Irradiation (ionizing radiation) equipment, including Xray, beta ray, gamma ray, and nuclear (medical,

dental, industrial, and scientific), n.s.k.

Electromedical equipment, including diagnostic,

therapeutic, and patient monitoring, but excluding

ionizing radiation equipment

Diagnostic:

Electrocardiograph (ECG)

Electroencephalograph (EEG)

Electromyograph (EMC)

Ultrasonic scanning devices

Automated blood and body fluid analyzers

Audiological equipment

Endoscopic equipment (bronchoscope, cystoscope,

proctosigmoidoscope, colonoscope, etc.)

Respiratory analysis equipment

All other diagnostic equipment

Therapeutic:

Pacemakers

DefibrilIators

Electrosurgical equipment

Diathermy apparatus (short wave and microwave)

Dialyzers

Ultrasonic therapeutic equipment

All other therapeutic equipment

Patient monitoring:

Intensive care/coronary care units, including

component modules such as temperature, blood

pressure, and pulse

Perinatal monitoring

Respiratory monitoring

All other patient monitoring equipment

Surgical support systems:

Heart-lung machines, excluding iron lungs

Blood-flow systems

All other surgical support systems

Parts and accessories for diagnostic, therapeutic,

monitoring, and surgical support systems (sold

separately)

Electromedical equipment, including diagnostic,

therapeutic, and patient monitoring, but excluding

ionizing radiation equipment, n.s.k.

X-ray, electromedical and electrotherapeutics apparatus,

n.s.k., typically for establishments with more than 5

employees

X-ray, electromedical and electrotherapeutics apparatus,

n.s.k., typically for establishments with less than 5

employees

3641-Surgical and medical instruments and apparatus

Surgical instruments, including suture needles, and eye, ear,

nose, and throat instruments

Orthopedic instruments, such as bone drills and bone

plates, excluding eye, ear, nose, and throat instruments

Diagnostic apparatus:

Metabolism and blood pressure

Optical diagnostic

Other

Syringes:

Other than hypodermic

Hypodermic:

Uniquely designed for prebilling

Other

Hypodermic needles

Anesthesia apparatus, instruments, and parts

Oxygen tents

Veterinary instruments

Blood transfusion and intravenous equipment

Blood donor kits

Mechanical therapy appliances and parts thereof

Other surgical and medical instruments

Surgical and medical instruments, n.s.k.

Hospital furniture, excluding beds and chairs

Operating room furniture, including tables, cases,

cabinets, etc.

Patient room furniture, including cabinets, overbed tables,

desks, dressers, etc., but excluding beds and chairs

Other hospital furniture, excluding operating and patient

room furniture, beds, and instruments, but including

cases, tables, bassinets, chart racks, backrests, etc.

Hospital furniture, n.s.k.

Surgical and medical instruments, n.s.k. typically for

establishments with 5 employees or more

Surgical and medical instruments, n.s.k., typically for

establishments with less than 5 employees

3642-Surgical appliances and supplies

Surgical, orthopedic, and prosthetic appliances and supplies

Orthopedic appliances (braces), including parts

Sterilizers (hospital and surgical), excluding dental

sterilizers

Surgical dressings:

Bandages, elastic

Bandages, other, including muslin, plaster of paris, etc.

but excluding self-adhering bandages

Adhesive plaster, medicated and nonmedicated,

including self-adhering bandages

Gauze (absorbent and packing)

Cotton, including cotton balls (sterile and nonsterile)

Other surgical dressings, including sponges,

compresses, pads, etc.

Disposable surgical drapes, including O/B and O/R packs

Disposable incontinent pads, bed pads, and adult diapers

Sterile surgical sutures:

Absorbable

Nonabsorbable

Artificial limbs (prosthetic), including parts

Elastic stockings
24 • Federal Policies and the Medical Devices Industry

Table 7.—Products in the Medical Devices Industry by SIC Code—continued

SIC code/products SIC code/products

Elastic braces, suspensories, and other elastic supports

Arch supports and other foot appliances

Corn remover pads, bunion pads, etc.

Breathing devices, excluding anesthetic apparatus but

including incubators, respirators, resuscitators,

inhalators, etc.

Surgical corsets

Crutches, canes, and other walking assistance devices

Splints and trusses

Wheel chairs

Other surgical orthopedic, and prosthetic appliances and

supplies

Surgical, orthopedic, and prosthetic appliances and

supplies, n.s.k.

Personal industrial safety devices

Respiratory protection equipment, including gas masks,

abrasive masks, canister masks, etc.

Eye and face protection devices, including face shields,

hoods, and welding helmets and masks, but excluding

industrial goggles and eye protectors

Protective clothing, except shoes

First aid snake bite and burn kits, both household and

industrial types

Other personal safety devices

Personal industrial safety devices, n.s.k.

Hearing aids, electronic:

Hearing aids, electronic

Surgical appliances and supplies, n.s.k., typically for

establishments with 5 employees or more

Surgical appliances and supplies, n.s.k., typically for

establishments with less than 5 employees

3843-Dental equipment and supplies

Dental metals:

Precious

Nonprecious

Dental alloys for amalgams

Teeth, excluding dentures:

Porcelain

Other, including resinous and plastic

Denture-base materials

Dental chairs

Instrument delivery systems (dental units)

Dental hand pieces

Other dental professional equipment, except X-ray

Dental laboratory equipment, including furnaces, casting

machines, lathes, benches, polishing units, flasks,

blowpipes, presses, etc.

Dental hand instruments (forceps and pliers, brosches,

cutting instruments, etc.)

Burs, diamond points, abrasive points, wheels, disks, and

similar tools for use with hand pieces

Dental cements and other non-metallic filling materials

Waxes, dental gypsums, and other consumable supplies

Other dental products including sterilizers, but excluding Xray equipment

Dental equipment and supplies, n.s.k., typically for

establishments with 5 employees or more

Dental equipment and supplies, n.s.k., typically for

establishments with less than 5 employees

3851-Ophthalmic goods

Ophthalmic fronts and temples

Fronts, finished (with or without decoration), and temples:

Gold filled fronts (full rimmed, semirimless, or rimless)

Aluminum and other base metal fronts

Plastic fronts

Combination fronts

Temples, all types

Ophthalmic fronts and temples, n.s.k.

Glass ophthalmic focus lenses

Single vision lenses (ground and polished and moulded

blanks)

Multifocal lenses:

Bifocals

Trifocals and double segments

Glass ophthalmic focus lenses, n.s.k.

Plastic ophthalmic focus lenses

Single vision lenses

Multifocal lenses

Plastic ophthalmic focus lenses, n.s.k.

Contact lenses

Conventional (hard)

soft

Contact lenses, n.s.k.

Other ophthalmic goods, n.e.c.

Centers, oxfords, parts, trims, etc.

Ophthalmic spectacles and eyeglasses (frames and

mountings of all types when sold with corrective

lenses inserted, with or without decoration)

Industrial goggles, eye protectors, welding circles and

plates, mountings, and parts

Sun or glare glasses and sungoggles, ready-made

Nonfocus fashion tinted lenses, plastic and glass

Other ophthalmic goods and accessories (sunglass

frames, single readers and magnifiers, holders,

gas mask inserts, etc.)

All other ophthalmic goods, n.s.k.

Ophthalmic goods, n.s.k., typically for establishments with 5

employees or more

Ophthalmic goods, n.s.k., typically for establishments with

less than 5 employees

an,e,c,—Not elsewhere classified.

n,s.k.—Not specified In kind.

SOURCE: U.S. Department of Commerce, Bureau of the Census, Annual Survey of Manufactures, Statistics for Industry Groups and Industries, 1977,
Ch. 2—Characteristics of the Medical Devices Industry • 25

Table 8.–Sales of Selected Medical Devices to Hospitals by SIC Code, 1982

Sales to Sales to

hospitals hospitals

(thousands (thousands

SIC code/product of dollars) SIC code/product of dollars)

X-ray and electromedical equipment

(SIC 3693)

X-ray supplies . . . . . . . . . . . . . . . . . . . . . . . .

Radiological catheters and

guide wire. . . . . . . . . . . . . . . . . . . . . . . . . .

Pacemakers and other

cardiovascular products. . . . . . . . . . . . . .

Electrosurgical supplies . . . . . . . . . . . . . . .

Surgical and medical instruments (SIC 3841)

Surgeons’ needles . . . . . . . . . . . . . . . . . . . .

Blood collection supplies . . . . . . . . . . . . . .

Thermometers . . . . . . . . . . . . . . . . . . . . . . . .

Surgical instruments . . . . . . . . . . . . . . . . . .

Syringes and needles . . . . . . . . . . . . . . . . .

Catheters, tubes, and allied products . . . .

Diagnostic instruments . . . . . . . . . . . . . . . .

Surgical appliances and supplies (SIC 3842)

Ostomy products ..........................................

Surgical packs and parts . . . . . . . . . . . . . . .

Maternity products . . . . . . . . . . . . . . . . . . . .

Dialysis supplies . . . . . . . . . . . . . . . . . . . . . .

Cardiopulmonary supplies. . . . . . . . . . . . . .

Sponges . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

$ 777,366

135,878

499,999

48,552

4,310

57,845

31,426

294,284

331,054

235,445

69,549

286,635

13,842

174,123

26,869

97,677

71,176

174,768

Bandages, dressings and elastic . . . . . . . .

Orthopedic supplies . . . . . . . . . . . . . . . . . . .

Parenteral supplies . . . . . . . . . . . . . . . . . . . .

Urological products . . . . . . . . . . . . . . . . . . .

Sterilizer supplies . . . . . . . . . . . . . . . . . . . . .

Cast room supplies . . . . . . . . . . . . . . . . . . .

Disposable kits and trays ... , . . . . . . . . . .

Respiratory therapy. . . . . . . . . . . . . . . . . . . .

Garments, textiles, and gloves . . . . . . . . . .

172,303

302,283

701,106

198,970

88,846

39,836

258,317

245,890

592,254

Ophthalmic goods (SIC 3851)

Ophthalmic-related products. . . . . . . . . . . . 83,649

Other

Solutions . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Medical supplies . . . . . . . . . . . . . . . . . . . . . .

Chemicals and soaps . . . . . . . . . . . . . . . . . .

Paper products . . . . . . . . . . . . . . . . . . . . . . .

Gases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Underpads . . . . . . . . . . . . . . . . . . . . . . . . . . .

Identification supplies . . . . . . . . . . . . . . . . .

Elastic goods . . . . . . . . . . . . . . . . . . . . . . . . .

Rubber goods . . . . . . . . . . . . . . . . . . . . . . . .

Total. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

872,985

420,702

153,946

113,738

109,933

55,259

31,517

24,932

7,281

$7,804,545

SOURCE: IMS America, Ltd. Rockville, MD, unpublished data, 1983.

ket for different devices. The highest sales to hos- Nondurable products are even more prominent

pitals are of disposable or nondurable items, such among the medical devices in a physician’s office.

as X-ray supplies and garments, textiles, and Table 9 lists the medical devices in an office of

gloves. For many of the devices with high sales two internists practicing in an urban setting. Alvolumes, hospitals account for only a portion of though the office contains basic medical furniture

the overall market. For example, parenteral sup- and equipment, most of the products predisposed

plies (for feeding through the bloodstream rather of after one use.

than the alimentary canal) are increasingly used

in home health care (see ch. 3) and X-ray supplies

are also purchased by independent diagnostic

centers and private offices.

CHARACTERISTICS OF MEDICAL DEVICES MANUFACTURERS

As indicated by table 3, the number of device are likely to have multiple plants. This pattern

companies is almost as large as the number of appears to be similiar to that in other industries.

establishments, with an average of 1.13 establish- For industries in which the four leading firms acments per company. This relationship implies that counted for between 40 and 64 percent of marthe mode in the medical devices industry is a com- ket sales, a situation similar to that in the medipany with one plant, although larger companies cal devices industry, the four leaders in 1963

25-406 0 - 84 - 3
26 • Federal Policies and the Medical Devices Industry

Table 9.—Medical Devices in an Internist’s Office

Medical fixtures:

(examining tables and other fixtures used for medical

purposes)

Examination rooms (2)

2 exam tables with stirrups and storage drawers

2 scales

1 treatment cabinet (large)

1 instrument cabinet (small)

1 eyechart

Laboratory

1 X-ray view box

1 test tube rack

1 sedimentation tube rack

Medical office supplies:

1 hanging medical record cabinet (7 tiers)

Manila chart folders

Printed forms for charts

Prescription blanks

Color-coded medical record stickers

Diagnostic supplies:

Cover slides

Urinalysis plastic cups

Wipes for urinalysis clean catch

Table paper

Drapes

Paper tape

Bili lab stix (dip-urinalysis)

K-Y jelly

Pregnancy test kit (urinary chorionic gonadotrophins

(UCG)-Beta slide)

Sedimentation tubes, cotton plug

Stains (Gran’s iodine-safranin, etc.)

Throat culture plates (oxblood 5%0)

Discs for throat cultures (Taxo A)

Uricults

Hemoccult slides (single and triple)

Electrocardiograph (EKG) -mounting paper, electro pads &

electrode cream

Sani vaginal specs size (S)

Sani vaginal specs size (M)

Anoscopes

Cards for tuberculosis test

SOURCE: R. Berenson, Washington, DC, personal communication, January 1984.

averaged 4.7 establishments per company and the

next four, 2.4 establishments per company; but

the remaining firms averaged only 1.08

establishments per company (274).

In 1977, medical devices establishments averaged 54 employees, about the same as the 53

employees per establishment for all manufacturing (362). Within the medical devices field, SIC

3693 (X-ray and electromedical equipment) had

the largest average size establishment with 127

employees, and SIC 3843 (dental equipment) had

the smallest with 30 employees (table 10).

Sclavotest purified protein derivative (PPD) tuberculosis test

Patient gowns (cloth)

Cloth tape measures

Thermometers

Gonococcus culture plates

Blood drawing tubes

Alcohol wipes

Sterile swabs

Swabs

Baggies

Cervi scrapes

Fixative spray for Pap slides

Slides (wet mount for Pap)

Cardboard containers for Pap slides

Culturettes

Gloves (reed Tru-touch)

Request slips for tests

Therapeutic supplies:

Gauzes

Syringes

Peroxide

Alcohol

Betadine scrub

Cidex 7 (long life)

Drug samples

Bandaids

Diagnostic equipment:

Examination rooms (2)

2 wall model Baumanometer blood pressure

instruments (3 cuffs)

1 EKG machine

2 Burton exam lamps

2 otoscope/ophthalmoscope desk units

Laboratory

1 centrifuge (provided on load by lab)

1 microscope

1 incubator

Therapeutic equipment:

Instruments (minor surgical--i.e., scissors, scalpels,

tweezers, etc.)

Despite the growth that has occurred in medical devices in recent years, there have not been

major increases in the average size of an establishment. In fact, for all of the major medical

devices SIC codes except X-ray and electromedical equipment and dental equipment, average

employee size fell from 1972 to 1977; for SIC 3693

(X-ray and electromedical equipment), it rose

from 116 to 127 employees per establishment, and

for SIC 3843 (dental equipment), it rose from 29

to 30 employees per establishment (362). From

these statistics, one may infer that, with the possible exception of X-ray and electromedical equip-
Ch. 2—Characteristics of the Medical Devices Industry ● 27

Table 10.–Size of Employment in Medical Devices Establishments by SIC Code, 1977

Number of establishments Percentage of all establishments Average number

by employee size by employee size of employees

SIC industry segment 1-19 20-99 100-499 > 500 1-19 20-99 100-499 >500 per establishment

SIC 3693: X-ray and electro

medical equipment . . . . . . . . . 117 55 55 16 4890 230/0 230/0 7% 127

SIC 3841: Surgical and

medical instruments. . . . . . . . 412 147 72 19 63 23 11 3 66

SIC 3842: Surgical appliances

and supplies . . . . . . . . . . . . . . 832 213 86 22 72 18 7 2 46

SIC 3843: Dental equipment

and supplies . . . . . . . . . . . . . . 431 85 30 4 78 15 5 1 30

SIC 3851: Ophthalmic goods . . 479 98 50 76 15 8 1 47

Total . . . . . . . . . . . . . . . . . . . . . 2,271 598 293 68 70% 19% 9% 2% 54

SOURCE: U.S. Department of Commerce, Bureau of the Census, 1977 Census of Manufactures, Industry Series, MC 774-38B and MC 77-I-36F (Washington, DC: U.S.

Government Printing Office, June 1980).

ment, growth has occurred through increases in the

numbers rather than in the size of establishments.

Although small establishments dominate in

number, they account for a much smaller fraction of total shipments in each SIC code (table

11), and these patterns have been extremely stable

since 1963 (393). The extremes are again represented by X-ray and electromedical equipment

and dental equipment. Among manufacturers of

X-ray and electromedical equipment in 1977,

establishments with fewer than 50 employees sold

only 5 percent of all shipments, but those with

250 or more employees sold 71 percent of all shipments. In the dental equipment field, establishments with fewer than 50 employees sold 21 percent and those with 250 or more employees sold

46 percent of all shipments (393).

There is some evidence that larger medical

devices establishments have higher profit rates

than smaller ones. One indicator of profits is the

difference between the cost of manufacturing a

product and the price for which it is sold. PriceTable il.–Market Share of Value of Medical Devices Shipments by Establishment Size, 1977, 1972, and 1963

Percentage of market share

Total of establishments by employee size

number

SIC industry segment of establishments 1-49 50-99 100-249 > 250

SIC 3693: X-ray and electromedical equipment

1977

1972

1963

sic 3841:

1977

1972

1963

sic 3842:

1977

1972

1963

SIC 3843:

1977

1972

1963

243

104

58

Surgical and medical instruments

650

506

294

Surgical appliances and supplies

1,153

873

704

Dental equipment and supplies

550

429

316

5%

7

6

12

11

15

13

12

12

50/0

4

11

9

11

11

8

6

8

19%

20

23

17

21

24

16

13

11

25

24

21

71%

69

60

62

57

39

63

69

69

46

39

36

SIC 3851: Ophthalmic goods

1977 634 15 5 17 63

1972 494 12 7 17 64

1963 229 9 14 12 65

SOURCES: U.S. Department of Commerce, Bureau of the Census, Census of Manufactures, Industry Series, for years 1963, 1972, and 1977, as cited in Arthur Young & Co.,

A Profile of the Medical Technology Industry and Governmental Policies, final report, vol. 1, June 30, 1961.
28 ● Federal Policies and the Medical Devices lndustry

cost margins have been calculated for medical

devices establishments with data from the Census

of Manufactures (table 12). According to these

1977 data, price-cost margins were highest for the

largest establishments. In only two of the five

codes, however, did the smallest sized establishments have the lowest margins. A serious problem

with these figures is that they overstate profits because they exclude costs such as research and development, advertising, and depreciation (18).

Small companies in the medical devices field

have a greater share of industry output than in

manufacturing generally (26). Companies with

one establishment account for 21 percent of all

sales of medical instruments and supplies and 31

percent of optical and ophthalmic goods, but only

16 percent of all manufacturing.5 Companies with

fewer than 250 employees account for 25 percent

of all sales of medical instruments and supplies

and 32 percent of optical and ophthalmic goods

as compared with 18 percent of all manufacturing.

The role of small firms in medical instruments

and supplies is comparable to that of those in electronic components in terms of number of establishments or total receipts. If firm size is defined

by number of employees, small medical instrument and supply firms with fewer than 250 employees account for a larger share of sales than

firms of a similar size in the electronic components

industry.

‘These data are compiled on the basis of companies rather than

establishments. The category optical and ophthalmic goods includes

products such as telescopes and other optical equipment and hence

is broader than medical devices (26).

Table 12.—Price-Cost Marginsa of Medical Devices Establishments by Employee Size, 1977

Margins of establishments by employee size

SIC industry segment Total 1-49 50-99 100-249 > 250

SIC 3693: X-ray and electromedical

equipment , . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0.406 0.374 0.275 0.398 0.422

SIC 3641: Surgical and medical instruments . . . . . . . . 0.394 0.326 0.360 0.368 0.420

SIC 3842: Surgical appliances and supplies . . . . . . . . . 0.374 0.307 0.322 0.355 0.400

SIC 3843: Dental equipment and supplies . . . . . . . . . . 0.325 0.283 0.360 0.274 0.366

SIC 3851: Ophthalmic goods , . . . . . . . . . . . . . . . . . . . . 0.352 0.350 0.297 0.351 0.357

aPrice-cost margins are calculated from Bureau of the Census data as follows:

Price-cost margin = ‘atue added – ‘ayro’t

Value of shipments

“Value added” is the value of shi ments minus materials, supplies, energy and certain other Input costs. It is defined by the Census on an establishment basis. Price-cost

margins are just one measure o !profltablllty; ~~ each different measure has advantages as well as disadvantages. Limitations of the price-cost margins are: 1) the mar ins

are overstated proxies of profitability since the Census does not provide directly comparable estimates of non-plant costs such as advertising, central office costs, F?&D,

and plant depreciation, and 2) the margins are conceptually inadequate because they fail to account for the industry’s capital intensity.

SOURCE: U.S. Department of Commerce, Bureau of the Census, 1977 Census of Manufactures, /ndustry Series, as cited in Arthur Young & Co., A Profile of the Medical

Technology /ndustry and Governrnenta/ Po/icies, final report, vol. 1, Washington, DC, June 30, 1981.

CONCENTRATION IN THE MEDICAL DEVICES INDUSTRY

The extent to which sales are concentrated to 45 percent of the sales in the medical devices

among a few companies is a measure of the com- SIC codes (table 13). By comparison, in 43 perpetitiveness of an industry. Despite the large num- cent of all U.S. manufacturing industries during

ber of companies, especially small ones, concen- 1972, the four leading firms had 40 percent or

tration in the five medical devices SIC codes is more of the total market (274). In the five medisimilar to that in other manufacturing industries. cal devices codes, the share of the four or eight

In 1977, the four leading firms accounted for 32 leading firms has been continually declining since
Ch. 2—Characteristics of the Medical Devices Industry • 29

Table 13.–Market Share of Value of Medical Devices Shipments by Leading Companies, 1977 and 1963

Percentage of market share

Total number of 4 leading 8 leading

SIC industry segment companies companies companies

X-ray and electromedical equipment (SIC 3693)

1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 212 32% 51%

1963 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56 67 79

Surgical and medical instruments (SlC 3841)

1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 575 32 48

1963 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 256 47 58

Surgical appliances and supplies (SIC 3842)

1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,017 38 49

1963 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525 49 58

Dental equipment and supplies (SIC 3843)

1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 507 33 46

1963 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 37 50

Ophthalmic goods (SlC 3851)

1977 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 593 45 56

1963 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 211 53 62

SOURCES: U.S. Department of Commerce, Bureau of the Census, Certsus of Manufactures, /ndustry Series, foryears 1963 and 1977, ascitedin U.S. Departmentof

Health and Human Services, Food andDru Administration, Office of Planning and Evaluation, Base/ine Data on the Avaflabflity ofMedica/ Devices and

/n-Vitro Diagnostic Products, OPE Study 5 , Washington, DC, 1980. f

1963, with the possible exception of SIC 3841(surgical and medical instruments), whose ratio increased slightly from 1972 to 1977.

As one would expect, the field appears to be

much more concentrated at the level of more specific products. The 1977 Census of Manufactures

reported the number of companies with shipments

of $100,000 or more for each product line. SIC

3693 (electromedical equipment) had four product types with only one manufacturer, and SIC

3842 (surgical appliances and supplies) had one

product with a single manufacturer (393). The

products in the other SIC codes, which varied in

their level of detail, all had more than one manufacturer, although the numbers were sometimes

small.

Data from IMS America on sales to hospitals

indicate that a small number of companies have

a large share of the market for specific devices

(table 14). For sutures, the four leading companies

accounted for 99.9 percent of all sales. Market

shares over 96 percent were also held by the four

leading firms in surgeons’ needles, blood collection supplies, and ostomy products (for discharge

of intestinal contents or urine through an artificial opening). The lowest market shares of the

four leaders, which were still substantial were 43

percent for garments, textiles, and gloves and 45

percent for respiratory therapy devices. Several

companies have large market shares across a range

of products. As shown in table 15, American Hospital Supply Corp. is one of eight leading firms

in 21 of the 28 product categories listed in table

14, and Johnson &Johnson is one in 14.

Prices for products in SIC medical devices codes

have increased at rates comparable to those in

other manufacturing industries. Available indexes

measure price changes in a given market basket

of products and do not incorporate new products

or changes in old ones, a serious deficiency for

the innovative medical devices field. From 1972

to 1982, product prices rose at an annual rate of

9.5 percent for SIC 3693 (X-ray and electromedical equipment), 8 percent for SIC 3841 (surgical

and medical instruments), 7.3 percent for SIC

3842 (surgical appliances and supplies), 7.7 percent for SIC 3843 (dental equipment and supplies),

and 5.9 for SIC 3851 (ophthalmic goods) (369,

375). During that time, product prices increased

at an annual rate of 9.2 percent for all manufacturing industries and 6.7 percent for the electrical and electronic equipment industry.

The lower rate of price increase in ophthalmic

goods is consistent with the case of contact lenses.

From 1971 to 1982, the list price of soft contact

lenses fell 50 percent, a result of competition

among fitters as well as among producers of the

lenses (275). The mature hard lens sector, which

exhibits little evidence of economies of scale in

production, has few dominant firms and has been

highly price-competitive for several years. In the
30 ● Federal Policies and the Medical Devices Industry

Table 14.—Leading Companies’ Market Share of Hospital Sales of Medical Devices, 1982a

Percent market share

Sales to hospitals 4 leading 8 leading

SIC code/product (thousands of dollars) companies companies

X-ray and electromedical equipment (SIC 3693)

X-ray supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $77,366 89.3% 98.2%

Radiological catheters and guide wire . . . . . . . . . . . . . . . . . . . . . . . . . 135,878 85.3 92.8

Pacemakers and other cardiovascular products . . . . . . . . . . . . . . . . . 499,999 73.7 88.9

Electrosurgical supplies . . . . . . . . . . . . . . . . . . . . ., . . . . . . . . . . . . . . . . 48,552 58.9 82.6

Surgical and medical instruments (SIC 3841)

Surgeons’ needles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,310 96.5 99.6

Blood collection supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57,845 96.4 99.1

Thermometers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31,426 78.8 92.3

Surgical instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294,284 68.1 81.2

Syringes and needles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 331,054 65.7 80.9

Catheters, tubes and allied products . . . . . . . . . . . . . . . . . . . . . . . . . . . 235,445 60.8 81.6

Diagnostic instruments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69,549 59.5 77.8

Surgical appliances and supplies (SIC 3842)

Sutures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286,635 99.9 100.0

Ostomy products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,842 97.9 99.6

Surgical packs and parts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174,123 84.1 95.1

Maternity products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26,869 82.3 91.8

Dialysis supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97,677 81.5 93.3

Cardiopulmonary supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71,176 79.4 98.0

Sponges . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174,768 78.9 88.4

Bandages, dressings and elastic 172,303 77.3 87.5

Orthopedic supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302,283 74.5 83.8

Parenteral supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 701,106 72.6 91.9

Urological products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198,970 71.7 86,8

Sterilizer supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88,846 71.4 83,5

Cast room supplies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 39,836 62,2 78.6

Disposable kits and trays . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 258,317 46.7 63.1

Respiratory therapy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245,890 45.1 67.4

Garments, textiles, and gloves . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 592,254 43.7 61.1

Ophthalmic goods (SIC 3851)

Ophthalmic-related products . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83,649 67.9 93.3

alMs AmeriCa’S l+ospital SIJ@Y index also has nifleothercategories that are not included here: elastic goods, identification SUpplif3S, SOIUtiOnS, chemicals and

soaps, gases, medical supplies, paper products, rubber goods, and underpads.

SOURCE: IMS America, Ltdv Rockville, MD, unpublished data, 1983.

Table 15.—Eight Leading Companies in Hospital Sales of Medical Devices in Three

or More Product Categories, 1982a

. 

Number of product categories Number of product categories

in which company is one of

Company

in which company is one of

eight leading companies Company eight leading companies

American Hospital Brunswick Corp.. . . . . . . . . 4

Supply Corp. . . . . . . . . . . 21 Lilly . . . . . . . . . . . . . . . . . . . . 4

Johnson & Johnson . . . . . 14 Cordis/Cordis Dow.. . . . . . 3

Colgate-Palmolive . . . . . . . 8 Dart Industries . . . . . . . . . . 3

Baxter-Travenol . . . . . . . . . 7 Independent Lab . . . . . . . . 3

Bard, C.R. . . . . . . . . . . . . . . 6 Kimberly-Clark . . . . . . . . . . 3

Pfizer . . . . . . . . . . . . . . . . . . 6 Professional Med. P...... 3

Abbott . . . . . . . . . . . . . . . . . 5 Squibb . . . . . . . . . . . . . . . . . 3

Bristol-Myers . . . . . . . . . . . . 5 Terumo-America Inc. . . . . . 3

Minnesota 3M Labs . . . . . . 5 Warner-Lambert . . . . . . . . . 3

Becton Dickinson . . . . . . . 4 ——.. . . — aoutofthe zBprOduct categories listed in table 14.

SOURCE: IMS America, Ltd. Rockville, MD, unpublished data, 1983.
Box A.—Changes in the Clinical Laboratory

In the 1950s, I saw the marvelous technique of Folin-Wu, which was used in those days in order to determine

the patient’s blood glucose level, or as it is more colloquially known, the blood sugar. This entailed the mixing of

various chemicals in such a fashion as to cause after 45 minutes of smelly boiling, the development of a blue color

whose intensity was an indication of the amount of sugar which was present in the patient’s blood. It should be remembered that prior to this test, presence of glucose in the patient’s urine was determined by tasting the urine and in fact,

as is generally known, the term diabetes mellitus means sweet tasting and derives from the physician’s diagnosis of

excess sugar in the patient’s system by the test of urine tasting. I suspect that in some parts of the world, Folin-Wu

sugars are still being performed because they are cheap, work, and require only a basic knowledge of chemistry and

simple laboratory equipment. This is in contrast to the methods which we now employ, which involve a sophisticated

enzymatic reduction method. . . . In days past, the determination of the Folin-Wu sugar on 10 patients would entail

a full morning’s work for the skilled laboratory technologist in the pathology laboratory. Today, we can perform 150

glucose tests in 1 hour using the skills of a well-trained and educated high school graduate. The cost per test now is

on the order of a few pennies and the cost per test 20 years ago was considered to be inexpensive at $5.00 . . .

The clinical diagnostic laboratory or Department of Laboratory Medicine is routinely accepted today as a vital

component of modern health care. As recently as 30 years ago, however, that was not the case. What is now called

a Department of Laboratory Medicine, or in some centers, clinical pathology, was then part and parcel of the Department of Pathology. There were no commercial clinical laboratories to speak of and you could count the number of

manufacturers of capital laboratory goods on the fingers of one hand. If a physician wanted to know the quantity

of sugar in the patient’s blood, the test required about an hour and a half of preparation, boiling, and manipulation

before an approximation could be given of the amount of glucose in the patient’s blood—-and in fact, we weren’t measuring glucose; we measured reducing substances, that is, all of the sugar-like materials that were in the patient’s blood.

For that matter, there were very few constituents that we were able to chemically approximate just 30 years ago, . . .

Diagnostic biochemistry really began to flower in the 1950s and early 1960s when various enzymatic methods

were discovered for the determination of specific sugars, such as glucose, and other determinations were developed

for uric acid, urea nitrogen rather than the gross determination of nonprotein nitrogen, total protein, calcium and phosphorus, and other constituencies which appear to be useful in the daily management of patients who were ill and under

stress. . . .

In mid-1950, Dr. Skeggs at Western Reserve University had a rather ingenious idea, He automated, for the first

time in the clinical Laboratory, the mixing, sampling and reading of the constituents in the patient’s blood when he

automated the blood sugar using the continuous-flow autoanalyzer. That first single-channel autoanalyzer was sold

in 1957 by the Technicon Company. . . . With the invention and mass sale in the early 1960s of the single-channel

autoanalyzer, it suddenly became possible to perform a series of tests virtually without regard for the cost of labor . . .

In 1965, I recall being a first-year resident in pathology and witnessing the chief of the department bringing back

the first SMA 12 in Pittsburgh to our hospital in his station wagon. We set it upon saw-horses. He and the administrator

agreed that the instrument would not only provide 12 tests to the institution on every patient (at great savings) but

would also provide a charge to the institution in 1965 dollars of $20.00 per evaluation. That is comparable in 1984

dollars to $65.34 .. .

It should also be pointed out that these instruments all used large quantities of reagants as did the continuous

flow technology. This of course put the capital vendors into the reagent and parts business in a big way. In those

days we did not have the microchemical procedures that later evolved in the mid-1970s, and have been extrapolated

in the past few years to virtually all of the automated equipment which is used in the laboratory. Even if the cost

of running these instruments was high and the purchase costs were large, when compared to the then available manual

testing methods that were in vogue, these new instruments were a quantum leap forward in efficiency, quality, and

quantity of data base. . . .

Where we had in the mid-1950s and early 1960s the rare professional medical technologist performing reducing

substances on the patient’s blood manually at the rate of six tests per hour, by 1983 we had one registered medical

technologist supervising the production of one machine which has the capability of performing 1,$00 individual tests

per hour. Where them was virtually no capital equipment cost to do the few sugars in 1960, the capital equipment

cost in order to process the 2,300 samples per hour is on the order of $400,000.

%xcerpted from a paper prepawd for OTA by Lnpovieh (199).
Ch. 2—Characteristics of the Medical Devices Industry ● 3 1 ——. — . . .

younger soft lens sector, the four leading firms

control almost 70 percent of the market, but new

firms have entered and the concentration level has

declined steadily during the past 5 years.

There is some evidence that merger activity in

the medical devices field accelerated during the

latter part of the 1970s. Respondents to a survey

in 1981 said that only 4 percent of their companies

had been acquired by another firm, merged with

another firm, or acquired another firm from 1972

to 1975, but 23 percent answered affirmatively for

1976 to 1980 (197). By 1982, 100 of the 140 firms

belonging to the Pharmaceutical Manufacturers

Association produced diagnostic products and

other medical devices, accounting for an estimated

60 percent of all such sales (244).

INNOVATION IN MEDICAL DEVICES

A hallmark of the medical devices field has been

the introduction of new products and the refinement of old ones. Some innovations affect ordinary devices that are used frequently, such as

assembled surgical trays for operating rooms (2).

Others represent the application of sophisticated

technology to medical uses, such as nuclear magnetic resonance imaging. 6 This rapid innovation

in medical devices has certainly underlain much

of the growth in firms and sales in recent decades.

Although innovation in medical devices has not

been precisely documented, striking evidence is

provided by the changes in medical practice that

have resulted from new medical devices. In boxes

A and B, respectively, a pathologist and an ophthalmologist relate certain changes in clinical laboratories and ophthalmology that have been linked

to innovations in devices. Innovative devices have

been the basis for tremendous changes in clinical

laboratory procedures. Compared to a generation

ago, clinical laboratory tests can now be performed more accurately and quickly as well as

with fewer, less skilled personnel and at lower

cost .

The pace of innovation in ophthalmology described in box B is greater than one might expect

from the relative growth of the SIC code 3851

(ophthalmic goods). However, many of the new

or refined medical devices used in ophthalmology

are surgical instruments or electromedical equipment, which appear in other SIC codes. Similar

innovations have taken place in other areas of

medicine, such as digital subtraction angiography

6

See the separately published OTA case study on nuclear magnetic

resonance imaging by Steinberg and Cohen (291).

and CT scanning in diagnostic imaging and pacemakers and materials for hip joints in surgery.

Patents are frequently used as a measure of innovative activity in an industry. Such data have

limitations since not all inventions are patented,

several patents may pertain to a single invention,

and the propensity to patent is greater in some

fields than in others.

The number of patents granted by the U.S. Patent Office grew modestly through the 1970s. From

1968 to 1979, almost 22,000 applications were

filed for medical devices patents that were subsequently issued (table 16), representing 2 percent

of all patents (381). Compared with all U.S.

patents over the same period of time (see app. D,

table D-2): 1) while all patents have remained

essentially constant, medical devices patents increased moderately; and 2) while foreign-origin

medical devices patents as a percent of total medical devices patents increased from 20 to 30 percent over the 1970s, foreign-origin patents for all

U.S.-issued patents increased from about 30 to 40

percent. Individuals owned 37 percent of the medical devices patents, compared with 22 percent of

all patents, an observation suggesting the important role of individuals in the medical devices

field. Table 17 provides information on patenting

activity in specific medical device fields (see app.

D for further information on patents). Electrical

systems and diagnostic equipment using radiation,

for example, accounted for about 6 percent of all

medical devices patents. Strength in this area is

consistent with the rapid growth in sales, firms,

and employment that has characterized the related

segment of the medical devices industry (X-ray,
Box B.—How Ophthalmology Has Changed During My Career1

Ophthalmology is practiced mostly in private offices, the majority of the work being primary care

with attendant high-volume, low-disease rates, and the remainder at a tertiary level with great technical

sophistication and high-risk, high-reward surgery. Here is a description of ophthalmological technology

when I began my residency in 1956, and how it then changed. . . .

Measuring the refractive state of the eye is usually accomplished in two stages: objective and subjective. When I entered ophthalmology, the objective phase was almost invariably performed by the

practitioner’s using a small hand instrument called a retinoscope. In a darkened room, with the patient

gazing at a distant small light source that would not encourage accommodation, the examiner peering

through a sight-hole of the instrument along the axis of a light beam entering the patient’s pupil, is able

to gauge the nature of the optical system of the eye by the character of the small amount of light reflecting back from the patient’s retina. . . .

Objective testing has changed significantly during my career. There are now nearly 20 opticalelectronic devices commercially available for performing retinoscopy or some other very closely allied

objective test. These can all be operated by technicians who need not have any skills in the traditional

methods of refraction. . . .

Early in the 1950s, most sharp cutting instruments were still made of nonstainless steel, were handsharpened, and were used repeatedly. The cornea is extremely tough tissue to cut, and instruments for

opening the cornea to begin cataract surgery presented a particularly difficult problem. If the point of

such an instrument is only slightly dull, the surgeon must push it harder, and then it is likely to enter

the eye in a rush. A great improvement has been made in recent years with the introduction of disposable

blades. Each of these blades is very sharp, but, more important, they are predictable. The amount of

force required to use them is always the same, and the surgeon knows what to expect.

Another important advance in ophthalmic instrumentation for surgery has been the development

of better needles for suturing the ocular tissues. In the early 1950s, the needles were hand-honed, used

repeatedly, and had eyes that required threading, like ordinary sewing needles. Placing sutures in the

cornea with these needles did not allow great precision in apposition of the wound edges. Disposable

needles swaged onto the ends of the suture made a great advance. By the late 1950s, the new generation

of very sharp disposable swaged-on needles made placement of sutures a qualitatively different procedure. . . .

The next great changes in cataract surgery came about as the result of increased we of magnification. During the 1950s and 1960s, the operating microscope was a feature of every well-equipped ophthalmic operating room. However, the instrument was used primarily for corneal transplants, where

a higher level of precision of technique was clearly advantageous. The microscope improved in response

to the demands of the surgeons, and with improvements in the operating microscope the surgeons

demanded finer and finer needles and sutures. . . . During the decade of the 1970s, the operating

microscope became the standard for modern corneal and cataract surgery, and today it would be difficult to defend this type of surgery without the use of a first-class operating microscope. A good operating microscope today costs from $30,000 to $60,000 or $70,000, and with photographic and other optional attachments the price can go significantly higher. . . .

The first truly successful intraocular lens (IOL) implants were made of one rigid piece of plastic

(methyl methacrylate) placed in the anterior chamber of the eye, under the vault of the cornea, and

in front of the iris. . . . These lenses are still in use, but are falling into disfavor because the pressure

of the lens against the tissues holding it causes disturbances that can be serious. . . . There was a great

wave of enthusiasm for iris-supported lenses, but this began to wane about 2 or 3 years ago, when the

reports of bad long-term results began to accumulate. . . . The next shift in IOL implants has been toward

placing the IOL in the posterior chamber, the place behind the iris from which the patient’s own natural

lens has been removed . . . surgeons’ choosing to put IOLs in the posterior chamber has revived the

extracapsular operation, which leaves the posterior capsule in place to support the IOL.
34 . Federal Policies and the Medical Devices Industry

.——-——. — —. . . — —.- — —. . . . . . —.—.——.—-.

Table 16.—U.S. and Foreign Medical Devices Patents Granted by

U.S. Patent Office by Application Date, 1968-79

— ---- —..

Number Annual percentage change — — ——— —. — . —

United United

—Year Total — —States Foreign Total States Foreign. — ——— — ..- ———.

1979a 2,142 1,488 . - ,. 654 5.3% 2.0% 13.5%

1978a : 2,035 1,459 676 -4.8 - 7 0 14

197 7 2,137 1,569 568 3.8 1.6 107

1976 2,058 1,545 ‘: 1 3.2 0.1 13,7

1975 1,994 1,543 451 --0.5 1.8 -5.8

197 4 1,995 1,516 479 , 6.6 4.0 15,7

197 3 1,871 1,457 414 9 4 8.1 14,0

197 2 1,711 1,348 363 4.0 -1.0 28,3

197 1 1,645 1,362 283 6.1 8.2 -2.7

197 0 1,550 1,259 291 9.1 9.2 8.6

196 9 1,421 1,153 268 12,7 9.9 26.4

1968 1,261 1,049 212 --- -- -. —.——-

Total . . . . . 21,820 16,748 5072 — ..- ————-. . — - --. .—.—.— -—————.—.——

aThe average pendenc Y (1 P the delay between the flllng of a pat, t il I(II c il I(>I and I IS subsequent Issuance as a patent)

IS currently longer than 2 y ~ars I t Is estimated that 2 to 5 percent I I , I ‘I 7 ) ~pl I lcat Ions and 1 pel’cent of the 1978 appl lca

tlons were still pend~ng I . Ijnc 1983

SOURCE U S Department 1 ‘~eall~ and Human Services Food an,~ I J. ~, “Irr II lustr!itlor Of f!ce of Economic Analysts, Roc~vllle

MD comt Itat I II b I ibi I shed data frnm the I.J S P ?t{ I ie~. lark 3ffice C)ecernher 1983
Ch. 2-Characteristics of the Medical Devices Industry ● 3 5

Table 17.—U.S. and Foreign Medical Devices Patents Granted by

U.S. Patent Office by Source and Selected Categories, 1968-79

—-— .

Total number — -—–. . . . . Percentage of totalb

of U.S. and U s .

Category foreign patents’ Corporations Government Universities Individuals

Diagnostic equipment . . . . . . . . . . . . 3,037 56% 4% 30/0 37%

Respiratory methods . . . . . . . . . . . . . 1,042 55 2 c 43

Electrical systems . . . . . . . . . . . . . . . . . . 723 68 1 2 29

Implantable artificial

body members . . . . . . . . . . . . . . . . . 1,236 48 4 4 44

Dialysis and blood filters . . . . . . 440 68 4 2 26

Kinesitherapy equipment . . . . . . . . . . 1,015 32 1 1 66

Orthopedic devices . . . . . . . . . . . . . . . 590 21 1 1 76

Bandages and trusses. . . . . . . . . . . 1,880 46 1 1 52

Mediators. .......,. . . . . . . . . . . . . 2,502 61 1 1 37

Instruments . . . . . . . . . . . . . . . . . . . . . . . . 2,290 49 1 1 49

Dental equipment . . . . . . . . . . . . . . . ... . . . . 1,509 33 c 1 66

Ophthalmic equipment . . . . . . . . . . . . . . . 1,110 59 1 1 39

Miscellaneous, including incubators,

hearing aids, receptors, and baths . . . . . . 2,525 58 2 1 39

al”~lud~~ ~at~nt~ ~rant~d (as of J“n~1983) on applications filed from 1 g68_79, The average pendency (i.e., the delay between the filing Of a patent application and

its subsequent issuance as a patent) is currently longer than 2 years. It is estimated that 2 to 5 percent of the 1979 applications and 1 percent of the 1978 applications

were still pending in June 1983. One patent may be included i n more than one categol y

b percen tage s may not add up to 100 percent because of rounding

cLess than 1 percent.

SOURCE: U.S. Department of Health and Human Services, Food and Drug Adminlstratior, Off Ice of Economic Analysis, compilation of unpublished data from the

U.S. Patent and Trademark Office, December 1983

electromedical, and electrotherapeutics equipment,

SIC code 3693). Considerable activity also occurred in dialysis and blood filters, whose use has

been covered by Medicare since 1972 (see ch. 3),

and in diagnostic and implantable cardiovascular

devices (see ch. 5).

Both large and small firms play a role in the

innovation of medical devices, as they do in other

sectors of the U.S. economy (274). There is no

exact information, however, on the dynamic relationship between large and small medical device

companies. It has been suggested that small firms

introduce innovative devices and, after proving

their commercial potential, merge or are acquired

by larger, more stable companies (18). It is also

possible that larger companies and establishments

benefit from economies of scale, while the smaller

ones specialize in products or functions that are

not so dependent on scale (393).

INTERNATIONAL COMPETITIVENESS OF U.S. MEDICAL DEVICES

The United States has commanded a strong

position in the foreign trade of medical devices.

During the past decade, the surplus of U.S. medical devices exports over imports grew steadily until 1982. In 1983, the surplus fell from over $1 billion in 1982 to about $800 million (table 18). The

$2.3 billion of medical devices exported in 1982

represented 17 percent of total sales (22,368). From

1978 to 1981, U.S. exports of medical devices grew

about 19 percent a year, a substantial amount

even though it does not allow for the 9 percent

U.S. inflation rate at that time (219).7

U.S. foreign trade in medical devices contrasts

with U.S. total merchandise trade, which has run

a deficit (imports exceeded exports) for all but 2

years (1975 and 1976) since 1973 (358). The U.S.

See app. H on consensus standards related to international trade

and app. I on governmental regulation of foreign trade in medical

devices by six countries.
36 • Federal Policies and the Medical Devices lndustry

— . — — ——. . —

Table 18.–U.S. Exports and Imports of Medical Devices by SIC Code, 1979-83

Millions of dollars Percent change

SIC code 1979 1980 1981 1982 1983a 1982-83

X-ray and electromedical equipment (SIC 3693)

Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Surplus (deficit) . . . . . . . . . . . . . . . . . . . . . . . . .

Surgical and medical instruments (SIC 3841)

Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Surplus (deficit) . . . . . . . . . . . . . . . . . . . . . . . . .

Surgical appliances and supplies (SIC 3842)

Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Surplus (deficit) . . . . . . . . . . . . . . . . . . . . . . . . .

Dental equipment and supplies (SIC 3843)

Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Surplus (deficit) . . . . . . . . . . . . . . . . . . . . . . . .

Ophthalmic goods (SIC 3851)

Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Surplus (deficit) . . . . . . . . . . . . . . . . . . . . . . . . .

Total five SIC sectors

Exports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Imports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Surplus (deficit) . . . . . . . . . . . . . . . . . . . . . . . . .

$ 717

275

442

$ 839

312

527

$1,006

388

618

$1,026

487

539

$1,065

670

395

3.8%

37.6

—

410

146

264

485

174

311

566

195

371

605

222

383

585

255

330

-3.3

14.9

—

258

105

153

309

94

215

127

41

86

356

95

261

375

108

267

395

110

285

5.3

1.9

—

101

42

59

140

50

90

143

50

93

155

55

100

8.4

10.0

—

99

245

(146)

114

278

(164)

123

300

(177)

113

342

(299)

110

452

(342)

-2.7

32.2

—

$1,585

$ 813

$ 772

$1,874

$ 899

$ 975 —.——

$2,191

$1,028

$1,163

$2,262

$1,209

$1,053

$2,310

$1,542

$ 768

2.1%

27.5%

—

aEstimated

SOURCES: W.C. Bandy, U.S. Departmentof Commerce, Bureau oflndustrial Economics, Washington, DC, personal communication, January 1983; E. Arakak~ U.S.

Department of Commerce, Washington, DC, personal communication, February 1984; U.S. Department of Commerce, Bureau of Industrial Economics,

1984 U.S. /rrdustria/ Out/ook, Washington, DC, January 1984.

position in medical devices is especially noteworthy because the growing strength of the dollar

during the last decade increased the relative price

of U.S. exports as it decreased the price of U.S.

imports. That phenomenon did erode the U.S.

surplus in 1983. The surplus in medical devices

trade has also persisted during the recent recession,

despite the reduced buying power of our major

trading partners.

this category is heavily tied to export: 30 percent

of electromedical equipment and 24 percent of Xray equipment in 1983 were sold overseas (369).

As a result, sales of these devices are more dependent on fluctuations in exchange rates.

Electromedical equipment, with exports that

grew almost 25 percent annually from 1978 to

1981, accounts for most of the trade surplus in

SIC 3693 (219). Although it is common that the

U.S. share of the world market for a product declines overtime as other countries enter the field

and U.S. growth falls behind a faster growing

world market, this situation has not occurred with

electromedical equipment. The U.S. share of the

world market increased from 35 percent in 1975

to 47 percent in 1979 (219). Patient monitoring

systems and other diagnostic electromedical apparatus have accounted for the majority of these exports (371,372). In 1981, Japan, Canada, the

Netherlands, West Germany, and France purchased

almost half of U.S. exports in this subcategory.

Trade in X-ray products has been less favorable.

In1982, exports only slightly exceeded imports.

A deficit of $175 million was expected for 1983,

In 1983, the European Economic Community

was the outlet for 37 percent of U.S. exports of

medical devices, but Canada (14 percent) and Japan (10 percent) were the major individual purchasers. 8 The European Economic Community

also provided more than half of U.S. imports,

with West Germany (32 percent) and Japan (18

percent) the largest single sources (369).

Although U.S. production is greater in other

categories of medical devices, SIC 3693 (X-ray and

electromedical equipment) leads exports, with $1

billion or almost 50 percent of all U.S. foreign

sales of medical devices. Domestic production in

8These figures relate to SIC codes 3841, 3842, 3843, and 3693 but

exclude SIC code 3851 (ophthalmic goods),
Ch. 2—Characteristics of the Medical Devices Industry ● 3 7

.

with imports accounting for 33 percent of U.S.

consumption of all X-ray products (369). About

40 percent of all X-ray products imported during

1981 and 1982 were X-ray apparatus and parts

from West Germany (373,374).

Although SIC 3841 (surgical and medical instruments) showed a trade surplus in 1983, its position deteriorated from 1982: exports fell 3 percent

and imports grew 15 percent. About 15 percent

of the surgical and medical instruments produced

in the United States during 1983 were exported,

but only 7 percent of U.S. consumption came

from imports. Exports of surgical and medical instruments indicate the untapped potential of markets other than our traditional trading partners.

From 1978 to 1981, exports to Canada (17 percent) and the European Economic Community

grew about 12 percent per annum. Exports to the

Middle East (10 percent) and Latin America (18

percent), however, grew nearly 30 percent per annum (219,371).

SIC 3842 (surgical appliances and supplies), the

largest medical devices category in sales, has the

least relative involvement in foreign trade: only

7 percent of production is exported, and 2 percent of U.S. consumption is imported (369). From

CONCLUSIONS

The medical devices industry can be characterized as a field that has undergone enormous

growth in companies, establishments, employment, new products, and foreign trade. By all of

these measures, the experience of the medical

devices industry has exceeded that of manufacturing as a whole and of similar manufacturing

sectors. Growth in medical devices has apparently

occurred more by the addition of new companies

than by the expansion of old ones, an indication

that any barriers to entering the industry are not

prohibitive. Both small and large firms have important positions in this industry. Small companies are responsible for a greater percentage of

sales in the medical devices industry than in other

industries. But large companies have accounted

for the majority of sales, and a small number of

1982 to 1983, exports experienced a 5-percent increase, and imports rose almost 2 percent. Both

West Germany and Japan had sizable increases

in their exports to the United States.

Exports of devices in SIC 3843 (dental equipment and supplies), representing 12 percent of

production, increased 8 percent from 1982 to

1983. Imports, only about 5 percent of U.S. consumption, came mainly from West Germany and

Japan (369).

SIC 3851 (ophthalmic goods) is the only medical devices code that has had a persistent trade

deficit. Half of the imports consist of frames and

mountings for eyeglasses, which are supplied primarily by France, Italy, Japan, and Hong Kong.

Sunglasses, 38 percent of ophthalmic imports in

1981, came mainly from Japan and Hong Kong

(373). Unlike most products in the other medical

devices codes, ophthalmic goods are usually chosen and used by consumers rather than by medical providers. To the extent that use is discretionary or postponable, sales would be expected

to be more sensitive to changes in price and general economic conditions. That reduced exports

in sunglasses accounted for most of the fall in exports from 1981 to 1982 fits this pattern.

firms have a considerable share of the market,

especially in specific product lines.

There are, however, disquieting aspects to the

situation. This phenomenal growth has occurred

in a market where there is a consensus that technology, including medical devices, has sometimes

been used excessively (168,266,346). Policy initiatives, both public and private, are now under

way to improve the situation, chiefly by changing the way that medical providers are paid. In

addition, Federal policy regarding premarket approval of devices is under review. It is therefore

timely to analyze the likely effects on the medical devices industry of these and other policies,

a task that is undertaken in the remainder of this

report.
3.

Payment Policies for Health Care

and Medical Devices

We prefer to blame technology rather than our cultural institutions for the

great cost overrun of the American health care system –Dale R. Olseth
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 41

Third-Party Coverage of Medical Devices . . . . . . . . . . . . . . . . . . . . . . . . . 43

Methods of Third-Party Payment and the Demand For Medical Devices . . . . . . . 45

Hospital Payment ....., . . . . . . . . . . . . . . . . . . “... . . . . . . . . . . . . . . 47

Medicare’s DRGI-Hospital Payment System . . . . . . . . . . . . . . . . . . . . . . 48

Payment for Physicians’ Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Payment for Ambulatory Clinical Laboratory Services . . . . . . . . . . . . . . . . . 52

Payment for Medical Devices Used in the Home . . . . . . . . . . . . . . . . . . 54

Payment for Durable Medical Equipment . . . . . . . . . . . . . . . . . . . . . . . 55

Payment for Home Health Care Services . . . . . . . . . . . . . . . . . . . . . . . . . 59

The Financial Relationship Between the Third-Party Payer and Providers . . . . . . 63

Public Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 63

Per Capita Payment Systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64

Discussion and Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

Payment for Laboratory Testing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66

Payment for Devices Used in the Home. . . . . . . . . . . . . . . . . . . . . . . . . 67

Payment for Physicians’ Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68

Hospital Payment.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 70

Systemwide Reforms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72

LIST OF TABLES

Table No. Page

19. Impact of Medical Equipment on Per-Case Hospital Costs. . . . . . . . . . . . . . . . 50

20. Durable Medical Equipment (DME) Rental and Purchase

Reimbursement Expenditures, by Major Category,

All Participating Carriers, 1976 and 1977... . . . . . . . . . . . . . . . . . . . . . 58

21. Estimated Home Health Care Expenditures and Percent Distribution

by Source, 1981 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59

22. Medicare-Certified Home Health Agencies by Type of Agency . . . . . . . . . . . . 60
3 ■

Payment Policies for Health Care

and Medical Devices

.

INTRODUCTION

The market for health care services is more

complicated than most other sectors of the economy. The ultimate consumers of health care typically do not pay for services at the time they are

rendered; third-party payers—insurance companies, Medicare, Medicaid, and other Government programs—share in the cost of providing

medical services to their beneficiaries. Only about

32 percent of total personal health care expenditures are paid directly by patients (128).

The market for health care services is also complicated by the central role of the provider—the

physician, other health professional, or hospital—

in making decisions about the amount, kind, and

quality of services that the patient receives. Most

diagnostic and therapeutic medical procedures,

prostheses, and implants must be ordered by the

physician. Thus, the makers of medical devices

more frequently see the provider as the buyer than

they do the patient or consumer.1

Manufacturers of medical devices, like those of

other products, try to produce and price products to meet the demands of their market. If low

price is important to buyers, then, barring the existence of monopoly power,2 the producers will

attempt to make products that can sell profitably

at low prices. If price is not so important to customers, producers will focus on factors that are.

Since the system of third-party payment for health

care services influences the products that will be

bought and the prices that will be paid, it is a major determinant of the market for medical devices.

Payment issues also influence the long-run performance of the industry. In general, the success

1An important and growing class of devices are those made expressly for use in the home or by the consumer. These include selfcare products such as self-testing diagnostic kits and aids for handicapped people that are often marketed directly to the consumer.

‘This assumption is important in gauging the response of the industry to the preferences of consumers.

or failure of a technological innovation rests

partly on developers’ perceptions of its market

(201,232,264). Although technological opportunities may dictate what directions of advance

are feasible, the perceived existence of a market

for an innovation is necessary for the commitment

of research and development (R&D) funds or the

investment in commercialization. There is no

evidence to suggest that the medical device industry is different from other industries in this regard.

Other factors besides the payment system shape

markets for medical devices. Both the benefits and

costs of medical devices matter. First, the buyers

and users must perceive a device to be worthwhile. Devices that are unsafe, ineffective, or less

effective than their substitutes may not have a

market even in the presence of generous thirdparty payment. Gastric freezing is an example of

a device-bound procedure that was abandoned

soon after evidence accumulated that it did not

help ulcer victims, in spite of the willingness of

third-party payers to finance its use (114). However, many devices have been widely used even

though well-documented evidence of their effectiveness is lacking.

Second, the availability of an important new

device whose cost, configuration, or setting of use

currently limits or proscribes third-party payment

(an stimulate a change in payment policy. The

case of long-term hemodialysis therapy for endstage renal disease is a classic example (256). With

the development of a subcutaneous arteriovenous

shunt (a plastic tube connected to an artery and

a vein in the arm or leg) by Quinton and Scribner

In 1960, hemodialysis rapidly became accepted as

a life--extending therapy for victims of chronic

kidney failure.

In 1972, Congress extended Medicare coverage

for treatment of end-stage renal disease to the gen41

25-406 0 - 84 - 4
42 • Federal Policies and the Medical Devices Industry . . —... — . . . — —

Photo credit: National Kidney Foundation, Washington, DC

This man is undergoing hemodialysis for the treatment of end-stage renal disease (ESRD). Medicare began paying for

such treatment in 1973, and by 1982, expenditures for Medicare’s ESRD program were an estimated $1.8 billion.

era] population (Public Law 92-603), largely out

of a recognition that there occurred an estimated

7,000 to 10,000 deaths per year because of the

limited availability of dialysis facilities (256). This

program now pays $1.8 billion annually for hemodialysis for approximately 80,000 people (98).

Third, many new medical devices are perceived

to have such benefit that they are demanded

whether or not they are covered by insurers. In

dentistry, for example, many new materials have

been developed in the recent past (184,210), despite the fact that almost 70 percent of dental expenditures are paid directly by patients (128).

With the recognition that other factors affect

the markets for medical devices, this chapter describes how third-party payment, particularly

Federal payment programs, affects the kinds of

medical devices that are produced, the settings in

which they are used, and the prices at which they

sell.

Medicare and Medicaid, the two Government

health insurance programs, are responsible for

about 35 percent of payments for personal health

care made to hospitals, 23 percent of those to physicians, and 23 percent of all other medical expenditures (128). Private health insurance, including commercial (for-profit) insurance companies

and (not-for-profit) Blue Cross/Blue Shield plans,

accounts for another 33 percent of hospital and

35 percent of physician expenditures. Other Federal, State, and local government programs also

contribute 13 percent of personal health expenditures through the Veterans Administration (VA),

the military medical system and its related Civil-
Ch. 3—Payment Policies for Health Care and Medical Devices • 4 3

- —

ian Health and Medical Program of the Uniformed Three aspects of third-party payment can inServices (CHAMPUS) program, and Government fluence the potential market for medical devices:

owned and operated health facilities (128).

●

If all sources of third-party payment and Government funding are taken together, the individ- ●

ual consumer or patient bears a moderate proportion of the burden of personal health care expend- ●

itures in this country (32 percent). But the distribution varies widely by settings and types of tech- r .

the coverage of devices as benefits by thirdparty payers;

the methods used to determine the level of

payment for covered health services; and

the financial relationship between the payer

and the provider of health care.

nology. Patients pay only about 12 percent of hos- Each of these elements is discussed in the sections below. pital expenditures directly, but they pay 37 percent

of payments to physicians and almost 77 percent

of expenditures for eyeglasses and appliances

(128). The burden of payment also varies widely

in the population. Some people have comprehensive health insurance, although an estimated 32.7

million people under age 65—or about 16 percent

of the population under age 65—were without any

public or private insurance coverage in 1982

(295a). 3

3

The uncovered population increased dramatically between 1979 –

—-—.—

covered. Economic conditions in the period and increases in the costs

and 1982. In 1979, 14.4 percent of those under 65 years of age were of health insurance relative to other goods and services are responuncovered, and in 1982, 18.9 percent of those under 65 were un- s]ble for these changes (295,296).

THIRD-PARTY COVERAGE OF MEDICAL DEVICES

Economic theory predicts and empirical evidence confirms that the existence of insurance coverage for a technology increases the number of

such services used (29,233,279). It has also been

shown that the use of physician and hospital services varies inversely with the amount of costsharing required of the consumer (233). Not only

have people sought care less often under costsharing, but their total annual health expenditures

have been lower than for people without costsharing requirements. Insurance coverage also affects the adoption of new medical technologies.

In two studies, a positive relationship was found

between the proportion of a State’s population

with health insurance and the adoption of complex

and sophisticated facilities in hospitals (71,266).

Most health insurance plans are selective in

their definition of covered technologies. Insurers

avoid certain services whose use may be difficult

to predict or control. For example, mental health

services are frequently excluded from both public and private insurance policies, as are some

long-term care and home health services (55). The

Medicare program covers inpatient hospital care

more fully than other services but requires some

cost-sharing by beneficiaries and limits the number of hospital days covered.4 Physician services

and ambulatory laboratory services are covered,

but annual deductibles and copayments are required of beneficiaries. Other services, such as

outpatient drugs, eyeglasses, hearing aids, and

preventive services are either uncovered or covered to a very limited extent under Medicare (345).

Coverage decisions are often more complicated

than the all-or-nothing decision about general

classes of services. By statute, Medicare may pay

4Medicare consists of two separate but coordinated programs—

Hospital Insurance (Part A), and Supplementary Medical Insurance

(Part B). IJnder Part A, beneficiaries receive up to 60 full days of

hosp]ta] care per year after a deductible is satisfied. Part B, which

is voluntary and requires a premium, has both a deductible and a

benc+i, [,irv payment of 20-percent coinsurance.
44 ● Federal Policies and the Medical Devices Industry

—

only for services that are “reasonable and necessary” for diagnosis, treatment, or improved functioning of a malformed body member. Medicare

has refrained from establishing a definitive interpretation of reasonable and necessary and has

relied on a loosely structured and decentralized

mechanism to determine whether a specific service is covered. Under the present Medicare program, funds are passed from the Federal Government to many separate contractors (referred to

as intermediaries and carriers) who reimburse providers or consumers for the services delivered in

their areas

The contractors are responsible for implementing Medicare coverage policy. Decisions involving coverage of services, particularly new services, are often made on a case-by-case basis and

thus may vary from region to region. For example, prosthetic devices may be covered under

Medicare if they replace all or part of an internal

body organ or replace the functioning of a permanently inoperative or malfunctioning organ.

But communications aids, considered by numerous health professionals to be prosthetic devices,

are not specifically covered under Medicare. Coverage is largely at the discretion of the contractor (345).

A rather informal system exists for referral of

coverage issues that cannot be resolved by the

contractor to Medicare’s regional office and, if

necessary, to the Federal Health Care Financing

Administration (HCFA), which often turns to the

Office of Health Technology Assessment’ in the

Public Health Service for guidance. There is apparently some chance involved in which issues get

flagged for referral (343).

Medicare contractors vary widely in their identification of uncovered technologies, the decisions

5Coverage is important for new devices where payments are made

for each service delivered as in a fee-for-service system. In Medicare, coverage affects the services of physicians and other health

professionals more than hospitals, because they are paid on a feefor-service basis whereas hospitals are paid by the admission.

6The Office of Health Technology Assessment (OHTA) in the Department of Health and Human Services is the office in the Public

Health Service that is charged with advising HCFA on Medicare

coverage of specific technologies. OHTA is distinct from the Office of Technology Assessment (OTA), a staff agency of Congress

that performs studies requested by congressional committees and

has a Health Program.

they make concerning the coverage of specific

technologies, and their implementation of coverage decisions (51,79,343). In short, coverage of

some services, particularly new procedures, under

Medicare is variable and uncertain. Such uncertainty may reduce in the eyes of the developer the

expected monetary return from introducing a new

medical device whose coverage is questionable.

Increasingly, the manufacturers of new devices

have themselves approached HCFA for definitive

guidance on coverage (345), perhaps in an attempt

to reduce the interregional variation and uncertainty associated with the coverage process.

In general, third-party payers will not cover a

new device until it is approved for marketing by

the Food and Drug Administration (FDA) (see ch.

5). For example, Medicare will cover no drug or

device that is in the investigational category. It

is interesting to note, however, that the Medical

Device Amendments of 1976 (Public Law 94-295)

do not prohibit the manufacturers of an investigational device from selling their product to users.

The producer may charge a price for an investigational device that will recoup research, development, and production costs but may not make a

profit.

Although the buyers (health care providers)

generally cannot charge third-party payers directly for an investigational device, they can

sometimes charge for it through other, similar,

procedures that are already covered. ’ In the words

of one legal expert, “investigational devices pay

their own way” (84). This expert also noted that

large and small device-makers charge institutions,

practitioners, and patients for devices that are

available only under an FDA investigational device exemption (IDE).

Some investigational devices have become widely

diffused in the absence of either premarket approval or specific coverage by the major thirdparty payers. As an example of FDA’s policy of

limiting distribution of devices under IDE, the

agency recently issued a “guidance” letter to nine

manufacturers of yttrium aluminum garnet (YAG)

lasers (used in ophthalmology) limiting investigational uses to 500 patients in a 6-month period

— —- —

‘If the device is part of a research program, a research grant may

pay for its use.
Ch. 3—Payment Policies for Health Care and Medical Devices ● 4 5

.

because it was concerned that the widespread distribution of these devices still in the investigation

stage constituted commercialization (88).

Limitations on and exclusions from coverage

increase the difference between the out-of-pocket

price of covered and uncovered services. When

covered and uncovered services compete as substitutes for one another, the uncovered services

are at a distinct disadvantage. To have a chance

of being used, the uncovered service would have

to offer patient benefits sufficiently greater to

justify the higher out-of-pocket expense. The effect of differential coverage levels on the market

for a medical device depends, of course, on whether

the device is covered by most insurance plans,

which patient conditions are covered for payment,

whether substitutes for the device exist—and if

substitutes exist, whether these alternative services are covered under insurance policies as well.

The effects of a coverage decision on medical

devices vary with the specific characteristics and

conditions of use of devices. For example, a new

cataract removal procedure made possible by a

new device may lower the cost to the physician

of performing the procedure. The physician can

introduce the cost-saving method and bill the patient or insurer for the standard cataract removal

procedure (at fees that are not likely to reflect the

reduced costs).8 Thus, to the extent that new techniques or devices can be subsumed under existing

medical procedure categories, coverage is not of

great concern. However, if the cost of the new

approach is higher than the level of payment for

existing procedures, coverage becomes an impor-

‘See the section below on “Payment for Physicians devices” for

an explanation of this phenomenon.

tant milestone in the development of a viable market for the technique. Using old procedure codes

for the new technique will not be attractive to

physicians.

Although the introduction of some new medical devices may be discouraged by the practical

obstacles to third-party coverage, there is no

ongoing mechanism in Medicare to reverse coverage decisions when an existing device has been

found to be less effective than other approaches.

For example, Medicare has continued to cover intermittent positive pressure breathing (IPPB), a

mechanical ventilator for respiratory therapy

(246,272), despite the fact that several professional

societies have seriously questioned its value.

The history of IPPB also illustrates the important role of professional judgment in influencing

the use of a procedure. Despite the coverage by

third parties, the use of IPPB has decreased dramatically in the past decade (see box C) (20,43,

49,248,272).

Thus, it appears that the process by which

devices come to be covered (or removed from coverage) by third-party payers is idiosyncratic.

Under Medicare, some devices are “grandfathered”

into coverage by virtue of their age; some are covered by default because they can be paid within

preexisting medical procedure codes. Others are

denied coverage, or given very limited coverage

for a period of time. The degree of ease with which

a particular device receives the blessing of coverage from the major third-party payers appears to

have little to do with the device’s relative efficacy

or cost effectiveness (24) and more to do with the

accident of timing of its introduction to medical

practice.

METHODS OF THIRD= PARTY PAYMENT AND

THE DEMAND FOR MEDICAL DEVICES

Insurers use a variety of mechanisms to pay for ices to the beneficiary (less any deductibles and

covered services provided to their beneficiaries. coinsurance) up to a schedule of maximum alIn the simplest case, the insurer makes fixed in- lowances.

demnity payments to the beneficiary, who is responsible for paying the provider whatever is Medicare, Medicaid, and many Blue Cross/

charged. Other plans pay for the full costs of serv- Blue Shield plans enter into contracts with “par-
Box C.–Intermittent Positive Pressure Breathing (IPPB)

IPPB devices are mechanical ventilators which, once triggered by the beginning of the patient’s inspiration, deliver a single “breath” of air. Such devices can be adjusted for sensitivity so that even very

weak patients can trigger the machine with every attempted breath. The patient usually uses only a

mouthpiece, although a face mask can also be used (467).

The four basic functions of IPPB devices are: 1) to inflate the lungs fully; 2) to deliver any specified

mixture of gases (including room air) to the lungs; 3) to deliver aerosols (either bland, to moisten the

lung, or medicinal); and 4) to stabilize breathing. Common alternative respiratory therapy devices include blow bottles and incentive spirometers, which help inflate the lungs, and nebulizers, which deliver

aerosols. IMS data show that sales of IPPB devices have decreased by about one-third in the past 5 years,

while sales of nebulizers, for example, have doubled in the same period (166). Professional-journal articles have also reported that use of IPPB devices has decreased since the early 1970s (20,43,248,272).

Reasons for the decrease in IPPB sales and use are not related to payment policies. Rather, the medical profession began in the early 1970s to scrutinize criteria for respiratory therapy in general and the

administration of IPPB therapy in particular (266,287).

IPPB emerged out of World War II efforts to provide adequate ventilation for high-altitude pilots.

A landmark paper by Motley and his colleagues in 1947 (221) introduced the clinical use of IPPB to

the medical profession. The 1950s and 1960s saw the gradual diffusion of IPPB technology into hospitals

and homes (58,459). Criticisms of indiscriminate use were published, but use increased dramatically

nonetheless (25).

With the adoption of Medicare and Medicaid legislation in 1965, the public endorsed IPPB use.

No conscious decision to cover this procedure was e&r made; the technology was in widespread use

at the time of passage. Blue Cross/Blue Shield plans also covered treatments without question,

IPPB therapy was common long before any rigorous tests of its efficacy were made. The clinical

studies reported in the literature during its diffusion tended to use methods that were poorly designed

or difficult to duplicate (272). The lack of good clinical data exacerbated the controversy over its proper

use.

In the 1970s, several professional groups began to strongly question the use of IPPB devices. A 1974

National Heart and Lung Institute conference on the scientific basis of respiratory therapy concluded

that the literature on IPPB warranted closer examination of the technology, especially through controlled

clinical trials. By the time of the National Heart, Lung, and Blood Institute (NHLBI) conference in 1979,

respiratory therapy textbooks were beginning to emphasize more stringent criteria far IPPB use (467),

and the American Association of Respiratory Therapists (AART} had endorsed guidelines for we prepared by the American Thoracic Society (4).

Shortly after the 1979 conference, an OTA-contracted case study circulated a critical appraisal of

IPPB to a slightly different audience (272). With this report to give it credibility, the Blue Cross/Blue

ShieId Association began an assessment of IPPB use and insurance coverage, in cooperation with the

American College of Physicians and other professional groups (36).

While public awareness of the potential for IPPB overuse has risen, the controversy in the medical

profession has slowed considerably. “Consensus papers” such as the AART and Blue /Cross Shield

guidelines stiIl may find strong opposition on some points (278), but there has been little hard argument

carried in medical journals in the past few years. A 1981 NHLBI Task Force on Pulmonary Technology

did not even mention IPPB (402).
Ch. 3—Payment Policies for Health Care and Medical Devices . 47

—- . . . . . . . . . — —

ticipating” providers that specify the methods for

determining the level of payment that providers

will receive. Because of the importance of Medicare, Medicaid, and the Blue Cross/Blue Shield

plans as sources of revenue, these methods of payment are critical determinants of the market for

medical devices.

Methods of payment vary widely across insurers and settings of care. This section will focus

on current and proposed methods of paying for

inpatient hospital care, physicians’ services, laboratory tests provided in ambulatory care settings,

and services or devices used in the home. These

four components constitute over 80 percent of

health expenditures and make intensive use of

medical devices.

Hospital Payment

Public and private third-party payers were responsible in 1980 for over 83 percent of the revenues of community hospitals in the United States

(108). Private health insurance itself accounts for

38 percent, while Medicare and Medicaid comprise 42 percent. Individual patients are the source

of about 17 percent of the revenues of community hospitals.

Third-party payment for hospital care has traditionally taken two forms: payment of billed charges

and payment of incurred costs. Most commercial

insurance plans and about one-third of the 70 Blue

Cross plans pay hospitals their billed charges.’ In

1981, over one-half of the State Medicaid programs and about one-half of the Blue Cross plans

reimbursed hospitals for the “reasonable costs”

incurred in serving their beneficiaries (6,345).

Medicare is in the process of abandoning this

method of payment and moving to a new system,

discussed later in this chapter. Both of these payment methods (by charges and costs) pass the immediate burden of payment through the patient

to the third-party payer.

Charge- and cost-based third-party payments

encourage increases in health care expenditures,

because hospitals have no incentive to hold costs

.——-. .— -

‘A small percentage of commercial policies are indemnity plans,

where the insurer pays the patient a fixed amount, such as $100 per

day of hospitalization. Only about 10 percent of group policies written by commercial insurance companies are indemnity plans (456).

down. ’” Only to the extent that patients themselves react to costs (or charges) by taking their

business elsewhere (if they can) will the hospital

have an incentive to compete for patients in terms

of price, Since patients themselves pay so little

out-of-pocket for inpatient care, they have little

incentive to concern themselves with price. The

predominance of third-party cost- and chargebased payment has been held responsible for the

rapid increase in hospital expenditures (110).

The problem of growing hospital expenditure

inflation increased during the 1970s and led both

public and private third-party payers to modify

payment methods. A number of Blue Cross plans,

individual States, and now the Federal Government have turned to prospective payment .11 Although prospective payment methods vary widely

among States and payers, they have two features

in common: the amount that a hospital is paid

for services is set prior to the delivery of those

services, and the hospital is at least partially at

risk for losses or stands to gain from surpluses

that accrue during the payment period.

Evidence has accumulated that in recent years

some State-level prospective payment programs,

particularly those with relatively stringent systems, have had a moderating influence on hospital costs (33,60). What have these reductions in

hospital costs implied for the adoption of medical technology? Three studies of the impact of hospital prospective payment programs on the adoption of new capital equipment or equipmentembodied services suggest that prospective payment sometimes does affect technology adoption

and that the directions of effect depend on both

the specific attributes of the programs and the

characteristics of the new technology.

Joskow found that the number of computed tomography (CT) scanners located in hospitals in

a State in 1980 was negatively related to the number of years that ratesetting had been in effect

there (177). Hospital ratesetting also led to a shift

in the location of CT scanners to physicians’ of-

‘“Such incentives apply when costs of production are reimbursed,

as under Medicare, but differ when payments are below costs as

under some Medicaid programs (138).

“Prospective payment has also been called prospective reimbursement
48 ● Federal Policies and the Medical Devices Industry

— .—.— — — . —

fices. Cromwell and Kanak analyzed the impact

of specific State ratesetting programs on the availability of 13 different services in the hospital between 1969 and 1978 (72). Two States with stringent programs, New York and New Jersey, had

the most consistently negative effects on the availability of services. Other States’ programs showed

no consistent impact on service adoption.

Finally, Wagner and colleagues investigated the

impact of prospective payment in three States—

New York, Maryland, and Indiana—on the adoption of five new pieces of capital equipment: electronic fetal monitoring, gastroendoscopy, volumetric infusion pumps, automated bacterial susceptibility testing, and computerized energy management systems (448). The first three technologies are likely to raise the cost of care, while the

latter two are investments in equipment that is

cost-reducing in large hospitals. Under New York

State’s ratesetting program, fewer units of the

cost-raising technologies were adopted, and the

probability of large hospitals’ adopting the costsaving equipment increased. However, the prospective payment programs in Maryland and Indiana showed no such consistent effects on hospitals’ adoption behavior.

Medicare’s DRG Hospital

Payment System

In March 1983, Congress established a new

Medicare hospital prospective payment system

(Public Law 98-21). Beginning in October 1983,

Medicare began to phase in a system in which it

will pay hospitals a fixed price for treating each

admission in 470 separate diagnosis related groups

(DRGs) of patients. At this time, the price paid

for each admission in a particular DRG covers

hospital inpatient operating costs—leaving outpatient, teaching, and capital expenses reimbursed

on a cost basis for the time being.

The new system is a Medicare-only approach,

but the law allows Medicare to join State-run prospective plans to cover all kinds of payers. Support from private insurance companies and businesses for these systems is high. Thus, the Federal

move into prospective payment may presage a

more general adoption of this kind of payment

by States.

Because Medicare accounts for such a large percentage of hospital revenues, the new per-case

payment system should put into place strong incentives for hospitals to change their behavior

regarding the adoption and use of medical devices,

as well as all other inputs, because hospitals will

be able to retain any surplus and must bear all

deficits. One can expect the adoption of some

devices, particularly those that reduce the cost per

hospital stay, to be encouraged, relative to their

past experience. Compared to practice in the recent past, the adoption of cost-raising devices will

be discouraged, but the strength of that effect will

depend on the device. Some maybe less affected

if hospitals compete for admissions by adopting

new device-embodied services, while others that

do not affect the competitive position of hospitals are likely to face a more hostile adoption environment (see box D for more detail).

The new Medicare payment system should also

alter the settings in which services are delivered

to Medicare patients. In particular, the use of

nursing homes and home health care should increase as hospitals seek to reduce the lengths of

stay of Medicare patients. Moreover, payment for

care delivered in these settings is not so constrained as that in the hospital. Devices that can

be used in the home should find an increasing

market.

Some observers are predicting, for example,

that the already growing market for parenteral

and enteral nutrition (techniques of direct feeding

into the bloodstream or gut) in the home will be

increased by DRG payment, and that hospitals

will enter the market as providers of after-hospital

home care in direct competition with other providers, some of whom are manufacturers of equipment and supplies for parenteral and enteral nutrition (34).

The law may also influence the pricing behavior

of device manufacturers. As hospitals become

more price-conscious with the advent of per-case

payment, they are likely to increase their use of

group purchasing, standardization of purchasing,

and competitive bidding for equipment and supplies. Group purchasing as a phenomenon has

grown rapidly among hospitals in the United

States, with an estimated 88 percent of hospitals

belonging to a purchasing group in 1981 (99), but
Ch. 3-–-Payment Policies for Health Care and Medical Devices ● 4 9

. 

it is still largely confined to drugs and hospital

supplies as opposed to equipment.

There is some evidence that the VA has been

able to exact significant price concessions from

manufacturers through its competitive contract

purchasing system (see ch. 7) A recent survey of

25 hospitals in 10 States by the Inspector General of the Department of Health and Human

Services (DHHS) found that the price of cardiac

pacemakers for Medicare patients was about 17

percent higher than the price paid by the VA

1271

As hospitals face increasing pressure to reduce

The costs per admission under the new payment

system standardization of purchasing behavior

is likely to occur, reducing the range of choice

[,(!, physicians and allowing hospitals to reap

~, I ~ I benefits of increased market power. The ex-
50 ● Federal Policies and the Medical Devices Industry

..——— —-.. .— .

pected result in any particular device category is

narrower price ranges and less variation among

products.

An unresolved issue with important implications for medical devices is how Medicare will pay

for hospitals’ investments in capital plant and

equipment in the future. For the present, the

method of payment for capital costs (depreciation,

interest, and return-on-equity to for-profit institutions) has not been changed. Capital expenditures ‘are reimbursed as they are incurred, on a

cost basis. Congress has expressed an intention

to include payment for capital by 1986 as part of

the prospective payment rate, but no specific

method has been selected.

The present cost-based method of capital payment is inefficient because hospitals have little incentive to weigh the costs and benefits of purchases and hence are likely to adopt and use

medical equipment regardless of the cost effectiveness. Table 19 indicates how hospitals’ incentives

to adopt different kinds of capital equipment

under DRG payment are influenced by a passthrough of capital (payment of the capital costs

that are incurred).

The capital payment method does not reverse

incentives of DRG payment so long as the effect

on total hospital costs of a medical equipment purchase is in the same direction as its effect on operating costs. For example, DRG payment provides

a disincentive to adopt most cost-raising, qualityenhancing (Type I) capital equipment. Regardless

of the way capital costs are handled, such purchase would raise operating costs. The capital

passthrough weakens the disincentive to adopt

this kind of technology, but it does not remove

it. Since DRG payment sets up incentives for hospitals to increase admissions, they have a financial interest to seek cost-raising equipment whose

availability promises to bring in profitable admissions by attracting physicians and patients. A capital cost passthrough essentially subsidizes this

kind of investment, leading potentially to wasteful

duplication of these services among hospitals.

With equipment that saves operating costs

(Type II) or capital costs (Type III), there can be

situations where the policy regarding payment for

capital may actually reverse the incentives of DRG

payment regarding adoption. Of particular concern is the incentive under a capital passthrough

to adopt expensive capital equipment that reduces

operating costs but raises total cost per case. For

example, with a capital passthrough, automated

laboratory equipment might be evaluated in terms

of its ability to reduce operating costs, with inadequate regard for its impact on total costs. And

a more labor-saving capital-intensive system

might be preferred regardless of its impact on net

costs.

New, inexpensive equipment that replaces older,

more costly equipment but only at the expense

of increasing operating costs (Type III) will also

be discouraged in a DRG system with a capital

cost passthrough even if its adoption would decrease total costs (Type III-B). Over time, then,

hospitals can be expected to become more capitalintensive than efficiency would dictate if the capital passthrough is continued.

Table 19.—lmpact of Medical Equipment on Per-Case Hospital Costs

Direction of effect of equipment

purchase on: Incentives for adoption

Capital cost Operating cost Total cost With capital Without capital

Type of equipment per case per case — .

per case in DRG rate in DRG rate

.

1. Cost-raising, quality-enhancing

equipment . . . . . . . . . . . . . . . . . . . . . . . + + +

Il. Operating cost-saving equipment

—

A. Raises total costs . . . . . . . . . . . . + + +

B. Saves total costs . . . . . . . . . . . . . + + +

Ill. Capital cost-saving equipment

A. Raises total costs . . . . . . . . . . . . – + + —

B. Saves total costs . . . . . . . . . . . . . – + + —

———— —

SOURCE: Office of Technology Assessment
Ch. 3—Payment Policies for Health Care and Medical Devices . 51

.———— —.. ..— -

Payment for Physicians’ Services

As the primary gatekeeper for the use of medical procedures, the physician is a key actor in decisions bearing on the adoption and use of medical

devices. Most diagnostic and therapeutic services

must be ordered by a physician or provided under

a physician’s direction. Although the patient

always has the right to refuse services and can refrain from seeking care in the first place, this

course is restricted by consumers’ limited knowledge and a medical care system that exhorts that

patient to “follow doctor’s orders. ” The key role

of the physician is reinforced by extensive insurance coverage, which reduces the patient’s economic incentive to refuse or question services

(139).

In 1982, physicians received approximately 37

percent of their revenues directly from patients,

35 percent from private insurance, 18 percent

from Medicare, almost 5 percent from Medicaid,

and the remainder from private philanthropy and

other sources of Government support (128).

Third-party payers generally pay for covered

physicians’ services on a fee-for-service basis,

There are two primary approaches to determining levels of payment: the benefit schedule and

the fee screen (285). Under the benefit schedule

approach, the insurer pays the patient or physician a predetermined fixed amount for each covered service. In private insurance plans, the patient is responsible for paying the difference between

the physician’s fee and the amount of the benefit, as well as any deductibles and coinsurance.

The fee-screen approach, used by Blue Shield

plans, Medicare, and some Medicaid programs

and commercial major medical plans, pays the

physician’s actual charge (less coinsurance and

deductibles) up to some maximum amount that

is computed from profiles of the physician’s own

fees and those of other physicians in the same specialty and region. This fee-screen approach is generally referred to as the usual, customary, and reasonable (UCR) approach to payment. Medicare

uses a variant of the UCR system called customary, prevailing, and reasonable (CPR). Here, the

CPR will refer to the general system of computing

a payment rate based on historical and comparative profiles of physicians’ fees.

Under its CPR system, Medicare pays 80 percent of the “reasonable charge”: the lowest of the

actual charge, the customary charge, or the prevailing charge for a service. The customary charge

is the median charge for that service by the doctor, and the prevailing charge is the charge below

which lies 75 percent of all charges for that service by doctors in a particular specialty and geographic area. Unless the physician enters into an

agreement with the insurer to accept the CPR

amount as payment in full (i.e., accepts assignment), which occurs in about 50 percent of all

claims (113), the patient is responsible for paying the difference between the UCR rate and the

physician’s billed charge.

Beginning in 1976, increases in the Medicare

prevailing charge have been restricted to a rate

reflecting increases in personal income in the

United States and the costs of medical practice.

Over time, as physicians’ actual fees meet or exceed the prevailing charge, Medicare’s CPR system is becoming a de facto geographic- and specialty-specific benefit schedule. Thus, the difference

between benefit schedules and CPR methods is

rapidly becoming a moot point as far as the Medicare system is concerned.

The CPR system tends to put a premium on

performance of new procedures for which comparative screens have not been established. A physician can charge a high fee for a new procedure

and have it reviewed for its reasonableness by a

medical review committee. After these fees are

established and comparative screens are developed, the new procedure often remains highly

rewarded relative to old procedures, because there

is little financial incentive for physicians to lower

prices as time goes on.

Thus, devices that allow for the performance

of such new procedures should be highly valued

by physicians, other things being equal. (Note,

though, that new procedures may require a coverage decision, which may slow the adoption of

such devices by physicians. ) Gastroendoscopy is

an example of a new device-embodied procedure

that was introduced at high fee levels and that is
52 ● Federal Policies and the Medical Devices Industry

 .

today highly profitable to physicians who perform

the procedure in sufficient volume (448).

New procedures are typically device-embodied,

whereas the “thinking services” provided by physicians, even though they may embody advances

in knowledge, are generally incorporated in existing procedure categories, such as the office visit.

Hence, the bias toward higher rates of return to

new procedures generally represents a bias toward

device-embodied procedures relative to “cognitive

services. ”

Schroeder and Showstack analyzed four illustrative styles of medical practice, ranging from

infrequent to frequent use of laboratory tests that

can be performed in the office (277). Physicians’

net incomes increase as the intensity of laboratory procedure use increases. To deal with this

problem, it has been suggested that uniform benefit or fee schedules should be constructed on a

basis other than UCR, perhaps by experts reviewing data on the relative costs of procedures (137,

140). The effect of such a fee schedule on the use

of device-specific procedures or the adoption of

new ones would, of course, depend on the relative fees actually adopted. Should cognitive services be valued more highly relative to devicespecific services, physicians would, other things

Payment for clinical laboratory services delivered to hospital inpatients is part of the hospital

payment system described above. This section

focuses on issues in payment for laboratory services rendered to ambulatory patients.

Laboratory tests are generally ordered by physicians and are commonly offered by three kinds

of laboratories: those located in hospitals, those

located in physicians’ offices, and those independent of both hospitals and physicians’ offices. In

1977, there were an estimated 7,200 hospital laboratories, 50,000 to 80,000 physicians’ office laboratories, and an estimated 7,650 independent laboratories in the country (226,329,355).

The setting in which testing takes place is determined in part by the economics of laboratory

testing. As new automated chemical laboratory

technologies came to market in the 1960s, economies of scale in test production favored centralized testing in large independent laboratories,

whereas more recently the development of simple new tests such as enzyme immunoassay and

microprocessor-based equipment has favored decentralized testing in physicians’ offices. But the

methods of third-party payment also affect the

profitability of testing in different settings and

therefore influence the choice of testing location.

being equal, have an incentive to spend relatively Medicare’s methods of paying for ambulatory more of their patient-care time on them. laboratory tests are particularly influential for

Payment for Ambulatory Clinical

Laboratory Services12

Laboratory equipment, supplies, and reagents

represent an important and rapidly advancing

area of medical devices. Laboratory testing volumes have increased dramatically in the past decade, partly as a result of the development of new

tests and automated equipment and partly as a

result of third-party payment methods. Between

1972 and 1977, laboratory tests nearly doubled

for both hospital and ambulatory care (126). Hospital laboratory test costs increased from $2.2 billion to over $4 billion, and out-of-hospital tests

increased from 850 to 1,510 tests per 1,000 physician visits (126). During this same period, per

capita visits to physicians decreased from 5.0 to

4.8 (126).

IZThe material presented in this section is based on a background

paper prepared for OTA by Foster (120).

three reasons: first, Medicare beneficiaries represent a substantial proportion of laboratory test

use; second, in many States, Medicaid uses Medicare’s payment methods to pay for ambulatory

laboratory services; and third, physicians tend to

make decisions on the location of testing for their

practice as a whole, not on a specimen-by-specimen basis, further increasing the leverage of Medi-

(are program reimbursement decisions.

Medicare’s payment method for ambulatory

laboratory tests depends both on the setting in

which a test is ordered (i.e., whether hospital outpatient department or physician’s office) and the

setting in which it is performed (hospital, physician’s office, or independent laboratory).

Before July 1984, Medicare payments for tests

ordered during physician office visits were made

on a reasonable-charge basis under Part B, the

Supplementary Medical Insurance program. Pay-
Ch. 3—Payment Policies for Health Care and Medical Devices ● 5 3

——— -_..

ment for these services was 80 percent of the reasonable charge, after the beneficiary had met an

annual deductible payment (currently $75). The

reasonable charge for a laboratory test was determined by a CPR method of screening claims similar to that applied to physicians’ fees. The reasonable charge for a laboratory test, regardless

of where it is performed, is the lowest of the five

following separate limitations:

the actual charge billed for the service by the

physician or laboratory;

the customary charge of the laboratory or

physician for the test, calculated as the provider’s median charge in the previous year;

the prevailing charge in the locality, computed as the 75th percentile of all customary

charges for all participating laboratories or

physicians;

the lowest charge at which the test is widely

and consistently available (currently established for 12 common laboratory tests; or

the comparable charge paid by the private

insurers that serve as the Medicare carrier.

The customary charges of hospitals, physicians’

offices, and independent laboratories, regardless

of whether they use automated equipment, were

commingled to calculate the prevailing charge in

the locality, and all kinds of providers of such

services were subject to the same prevailing charge

or lowest charge limitation. Note also that this

procedure generally resulted in Medicare’s paying laboratories at a low rate relative to private

insurers.

Medicare can pay one of three different entities

for ambulatory tests: the beneficiary, the testordering physician who has accepted assignment,

or the testing laboratory that has accepted assignment (42 CFR, sec. 405.251(b)). Until a recent

change in the law, if the beneficiary sought reimbursement, he or she would receive from Medicare 80 percent of the laboratory’s reasonable

charge, less any deductible. The party billing the

beneficiary (whether it be a physician’s office, hospital, or independent laboratory) was subject to

no limitation on the amount that could be charged

the beneficiary, who had to make up the difference.

Under this method of payment, the physician

was in a unique position of having the power not

only to choose whether or not to accept assignment and bill Medicare directly, but also whether

to perform a test in the office or send the specimen

to an independent or hospital laboratory. If the

physician accepted assignment, the amount Medicare would pay depended on the information supplied on the physician’s claim for reimbursement.

If the claim indicated that the test was performed

in the office, Medicare would pay the physician

80 percent of the reasonable charge as described

above. If the claim indicated that the test was performed by an outside laboratory, Medicare would

pay the physician only the laboratory’s reasonable charge plus a $3 handling fee.

Before July 1984, Medicare reimbursement for

tests ordered during hospital outpatient visits was

based on 80 percent of the cost of the service to

the hospital and 80 percent of the reasonable

charge for any physician service provided in connection with the test. (The patient was responsible for paying the remaining 20 percent. ) Since

October 1983, HCFA treated most clinical laboratory tests performed in hospital laboratories not

as physicians’ services but as hospital outpatient

services. Consequently, the price was typically

based on the cost, not the charge, method.

In July 1984, Public Law 98-369 established a

new method for setting ambulatory laboratory

fees that represents a significant departure from

the traditional method described above. For a 3-

year period beginning in 1984, Medicare payment

for laboratory services will be established at a

fixed percent of the prevailing fee level (60 percent for physicians’ offices and independent laboratories, 62 percent for services to hospital outpatients). After 3 years, a national fee schedule,

presumably departing from the prevailing charge,

will be developed.

The new law expressly forbids physicians from

billing for laboratory services unless they are actually performed in the physician’s office. Physicians who conduct their own tests can still choose

whether to accept assignment, but the law contains a provision to encourage assignment. When

a physician accepts assignment, Medicare reim-
54 • Federal Policies and the Medical Devices Industry

—— — —- ..— .— ———— —— - —..—. —

bursement will be at 100 percent of the fee schedule amount (rather than 80 percent) and the coinsurance and deductible will be waived.

Independent laboratories must accept assignment, but Medicare will pay 100 percent of the

fee schedule and will waive coinsurance and deductible requirements. The handling fee (currently

$3) will be available to the physician or laboratory that collects the specimen.

Overall, Medicare’s payment method for laboratory tests encourages physicians to perform

tests in their own offices, especially when the expected per-test profit exceeds the $3 handling fee

(i.e., when the Medicare payment level plus additional payment by the patient exceeds per-test

costs in physicians’ offices by at least $3). Whether

this condition is met depends on the technical costs

of performing specific tests and the strength of

economies of scale in their production.

Tests requiring a heavy fixed investment in capital equipment may be economical only for the

highest volume group practices. But performing

tests in physicians’ offices eliminates transportation costs required of outside laboratories and the

extra costs associated with laboratory licensure

standards, to which physicians are not obligated

in most States. The recent emergence of simple,

inexpensive laboratory equipment and test kits

that can be operated at a profit at low volumes

has opened up a wide new physicians’ office market that clinical laboratory equipment manufacturers are seeking to fill (35).

The encouragement of testing in physicians’ offices, although an important new market for manufacturers, may not be the most rational use of

health care resources for two reasons. First, there

are situations in which the physician has a financial incentive to select the more costly setting. For

example, suppose the fee schedule rate for a test

is $9 and the cost of the test performed in an independent laboratory is $4.50 (including transportation), while a physician can produce the

same test at a cost of $5. Under both the old and

new reimbursement methods, the physician has

an incentive to produce the test in-house, regardless of the higher cost. When it is recognized that

the physician can refuse assignment on a claimby-claim basis and charge the patient more than

$9, the financial incentive to perform the test in

the office appears even stronger. Also, by expressly forbidding physicians from billing for services provided by independent laboratories, the

new law will further strengthen the incentive for

testing in physicians’ offices.

Second, there is suggestive evidence that tests

performed in physicians’ offices maybe of lower

quality than are tests performed by independent

laboratories (132a,183,212). Data from a national

proficiency testing program conducted by the

American Association of Bioanalysts revealed that

physicians’ office laboratories in the program produced substantially less precise and accurate test

results than did independent laboratories (132a,

‘183). However, the introduction of automated

laboratory technology may improve physician

laboratory performance in the future.

Medicare’s payment system also encourages

hospitals to expand their laboratory services to

outpatients and nonhospital patients. The new

prospective hospital payment system, which pertains only to inpatients, creates strong pressures

for hospitals to maximize the proportion of their

laboratory tests conducted on outpatients in order to allocate as many costs as possible to (and

reap as high revenues from) this less restricted

payment area. And to the extent that hospitals

can compete for business with independent laboratories, this additional source of revenue will

further help offset the laboratory-associated costs.

However, Medicare’s new laboratory payment

system may encourage some hospitals to refer the

bulk of their inpatient testing to highly automated

independent laboratories with competitive prices

in order to reduce inpatient costs. Thus, the role

of the hospital laboratory in the ambulatory laboratory testing market appears to be undergoing

fundamental changes—with the precise outcome

unknown at this time.

Payment for Medical Devices

Used in the Home

Medical devices used in the home include a wide

range of products—from disposable supplies such

as bandaids, incontinence aids, and pregnancy

tests, to long-lasting equipment such as wheel-
Ch. 3—Payment Policies for Health Care and Medical Devices ● 5 5 — — — — . —

chairs and hospital beds. Third-party coverage of

a device used in the home depends on specific

characteristics of the device and the patient. From

the standpoint of payment, four different kinds

of medical devices are:

Self-administered medical devices—devices

such as bandages, incontinence aids, thermometers, blood pressure monitors, or overthe-counter tests. These products are chosen

by consumers, not physicians, and most

third-party payers do not cover them. There

are some exceptions if the devices are prescribed by a physician.

Durable medical equipment (DME)–

equipment that can stand repeated use; is

generally not useful in the absence of illness;

and is appropriate for use in the home. These

devices are generally covered, provided they

are prescribed by a physician.

Home health care devices—devices used in

conjunction with health care services rendered in the home by health care professionals. Medicare and Medicaid cover these

devices, but their coverage by private insurers varies.

Home renal dialysis devices—equipment and

supplies used to provide home renal dialysis

to patients with end-stage renal disease, These

devices are covered by Medicare, with supplementary coverage provided by some private insurers.

Self-administered medical devices, if ordered

without a prescription, are rarely covered by

third-party payers; consequently, they can be considered traditional consumer goods and will not

be discussed in detail except to note that the lack

of insurance coverage for such devices puts them

at a disadvantage relative to devices provided by

physicians or other professionals. If these devices

are ordered by prescription, they are sometimes

covered under insurance policies, usually to the

same degree that devices provided in a physician’s

office would be covered. Self-administered devices

will be demanded if their purchase price and the

convenience they represent is competitive with the

out-of-pocket costs and convenience of using

alternative devices that are covered by third-party

payers.

Renal dialysis devices used in the home are

unique in that they are covered, by a uniform

Medicare payment system: Medicare’s End Stage

Renal Disease (ESRD) program. Since 1972, Medicare benefits have been available to all patients

regardless of age. The effect of the payment system on the kinds and prices of available dialysis

equipment and supplies, as well as on the settings

in which they are used, has been profound. A separate case study prepared for this report examines hemodialysis devices in detail (see box E)

(260).

The two other kinds of devices—durable medical equipment and devices provided as part of

home health care services—raise some interesting issues for Federal payment policy and are discussed in detail below.

Payment for Durable Medical Equipment

Hospital beds, wheelchairs, oxygen and its

related equipment, canes, and crutches are examples of DME. The Inspector General of DHHS

has projected total national (public and private)

expenditures for DME to reach $1.26 billion to

$1.58 billion in fiscal year 1985 (160). In 1982,

Medicare outlays for DME were about $310 million (158), up almost 150 percent from $125 million in 1979 (333).

These estimates do not include durable equipment provided to Medicare patients as part of

home health services, estimated at about $19 million in 1982 (158). Table 20 shows the distribution of spending for various types of DME by a

sample of Medicare beneficiaries in 1977. Interestingly, oxygen and oxygen equipment alone accounted for 46 percent of total expenditures for

rental and purchase of DME. Medicare expenditures for DME may increase even more with the

advent of DRG payment for hospitals. The incentive for hospitals to discharge patients early to the

home may lead to greater use of DME in the

recovery period.

DME is a distinct benefit category under Medicare’s Supplementary Medical Insurance program

(Part B of Medicare). Medicare generally covers

80 percent of the “reasonable” charge or cost of
Box E.—Medicare Payment for Renal Dialysis: Effect on Medical Devicesl

End-stage renal disease (ESRD) afflicts about 83,000 people in the United States (98). In the course

of treatment for this disease, most patients and their providers use an array of products produced by

the hemodialysis equipment and supplies industry. This industry is relatively new. Its whole existence

is a consequence of modern medical advances that have made hemodialysis a viable treatment for ESRD.

For patients with ESRD, the major alternative to kidney transplantation is dialysis, which offers

an artificial mechanism for performing kidney functions. In hemodialysis, blood is pumped from the

patient’s body, subjected to a process of dialysis, and then returned to the body in a continuous extracorporeal bIood loop. Patients on hemodialysis are typically dialyzed three times per week, for sessions ranging from about 31⁄2 to 5 hours each. These patients can be dialyzed at home or in hospitalbased or freestanding dialysis facilities or centers. Hemodialysis was the treatment for about 89 percent

of the patients with ESRD in 1982 (98).

Another form of dialysis, peritoneal dialysis, has been increasing in popularity in recent years. In

peritoneal dialysis, the process of dialysis occurs within the patient’s body rather than via an extracorporeal blood loop. Continuous ambulatory peritoneal dialysis (CAPD) involves a continuous dialysis

process and frees the patient from dependency on a machine. Used by about 10 percent of the ESRD

population in 1982, CAPD is the most popular form of peritoneal dialysis (98).

Since July 1973, the Medicare program has covered about 93 percent of the ESRD patient population (78). ESRD patients are enrolled under Parts A and B of the Medicare program+ Part A (Hospital

Insurance) covers the reasonable and necessary services received in a participating facility, including

inpatient dialysis. ESRD patients generally receive dialysis on an outpatient basis, covered by Part B

{Supplementary Medical Insurance). Under Part B, ESRD beneficiaries pay a monthly premium and are

entitled to payment of 80 percent of reasonable charges or costs above a deductible. Patients are responsible for the remaining 20 percent of charges.

Home dialysis has been covered under this same basic arrangement. Medicare pays 80 percent of

allowed costs for supplies and equipment and physicians’ services above the deductible. Since 1978, if

the patient obtained home dialysis and equipment from an approved facility that reserved the equipment for the exclusive use of patients on home dialysis, the 20-percent coinsurance requirement has been

waived.

In establishing the actual levels of payment for dialysis, the Medicare program had few precedents.

The early decision was to pay 80 percent of the average cost to a hospital-based dialysis facility, and

80 percent of the reasonable charges for a freestanding dialysis facility up to a screen (or limit) of $133

per treatment. If routine laboratory services were included, the screen was raised by an additional $5;

if the supervisory services of a physician were included in the facility’s costs, the screen was increased

by $12, to $150. These rates were in effect from 1974 until August 1983, when they were supplanted

by a new reimbursement method.

In 1982, prior to the new rules, nearly all freestanding facilities were being paid at the rate of $138

per treatment (78}. Most hospital-based facilities requested and were granted exceptions to the screen,

on the grounds that their costs were higher; the average hospital-based payment in 1982 had risen to

approximately $170 per treatment (78,356).

Under the old system, physicians could choose from one of two systems of payment: the initial

method and the alternative reimbursement method. Under the initial method, reimbursement for supervisory care was paid to a facility as part of its reimbursement rate. Other nonsupervisory services were

paid on a fee-for-service basis. Under the alternative method, physicians were paid a comprehensive

monthly fee per patient. For patients dialyzed in facilities, this fee was based on a calculation of the

customary or prevailing charges for a followup visit, multiplied by 20. For supervision of home patients,

the weighting factor was set at 14 rather than 20, to reflect the. presumed lower requirements of home

patients for physician supervision.
Ch. 3—Payment Policies for Health Care and Medical Devices ● 5 7

— —— —.. —

this equipment, subject to the annual deductible

amount. In practice, the reasonable charge is

determined by the CPR method described in sections above. The allowed rate of payment for a

particular item of DME is the minimum of the

DME supplier’s actual charge, the supplier’s customary charge (the median of supplier’s own past

charges) or the prevailing charge, defined as the

75th percentile of all purchase or rental charges

for the particular device in the locality during the

preceding year. 13

l~rhe DME reimbursement system IS currently under scrutiny by

HCFA and the General Accounting Off Ice for Its effects on users’

decisions whether to purchase or rent equlrlmen+ (92, 156,157,237

If the supplier agrees to accept the Medicare reasonable charge as payment in full (i. e., accepts

assignment), then the Medicare enrollee is liable

only for his or her 20-percent coinsurance plus

any deductible owed. But if the supplier does not

accept this payment, the beneficiary must pay the

difference between the reasonable charge and the

33.+ I incer ~ alnty about the duration of use of DME IS inherent in

the )at urt . It the service, but Medicare’s current system of payment

~)ro~ i(le~ ~naciequate incentives for users to purchase equipment, even

wh( n ~ I i> t,lirl v clear that such a decision would cost Medicare less

th~r rtmtal Although the issue has important implications for Medi-

( arc ex[wn( i It [ires, it does not influence choices among devices or

t,n( \T er,~: I I at(: of use of devices m any fundamental way and is

~11)’ i \( L \ ! i n this report

25-406 0 - 84 - 5
I

m

03

●

I

J1

Q

m

g

$

.

-.

0

-.

CD

v)

m3

Q

$

Table 20.—Durable Medical Equipment (DME) Rental and Purchase Reimbursement i $

Expenditures, by Major Category, All Participating Carriers, 1976 and 1977a Is

~ 5

1976 1977 ~:

Rental Purchase Rental Purchase 7

Category description

-.0

Dollars Percent Dollars Percent Dollars Percent Dollars Percent mCn

Hospital beds and accessories . . . . . . . . . . . . . . . $1,591,925 26.530/o $ 520,023 9“85°/0 $ 798,338 19.430/0 $ 867,895 13.81 0/0 s

Commode chairs, bedpans, urinals, Qc

and toilet accessories. . . . . . . . . . . . . . . . . . . . 232,862 3.88 158,948 3.01 148,765 3.62 218,369 3.47

Canes, crutches, and accessories . . . . . . . . . . . . 31,149 0.52 31,656 0.60 33,919 0.83 24,887 0.40 $

Traction equipment and accessories . . . . . . . . . 175,114 2.92 77,044 1.46 75,780 1.84 108,429 1.73

Walkers and walking aids. 202,821 3.38 170,110 3.22 151,566 3.69 172,573 2.75

Wheelchairs and accessories 1,091.624 18.19 536,966 10.17 736,903 17.93 644,866 10.26 I

Oxygen. . . . . . . . . . . . . . . . . . . — 0.00 2,598,333 49.21 — 0.00 2,323,585 36.98 ~

Pads and cushions . . . . . . . . . . 147,831 2.46 25,911 0.49 45,628 1.11 91,427 1.45 I

Miscellaneous DME. 16,570 0.28 18,077 0.34 188,614 4.59 19,450 0.3 1

Oxygen therapy equipmen t 1,963,170 32.72 816,872 15.47 1,183,791 28.81 1,349,534 21.48

Repair/maintenance . . . . . . . . . . . . . . . . . . . . . . 347,758 5.80 40,611 0.77 344,094 8.38 36,201 0.58

Unspecified DME . . . . . . . . . . . . . . . . . . . . . . . . . . . 199,920 3.33 285,558 5.41 401,552 9.77 426,464 6.79

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $6,000,744 1OO.O1°/o $5,280,109 1OO.OOO

/o $4,108,950 1OO.OOO

/o $6,283,680 100.01 0/0

aData not included from Equlptable Tennessee for 1977 or from Washington Physicians Service from NOV 1 through Dec. 31, 1977.

SOURCE T J Janssen and G T Saffran, ‘Reimbursement for Durable Med!cal Equipment, ” F/ea/th Care Finan. Rev. 2(3):94, winter 1981

I

I
Ch. 3—Payment Policies for Health Care and Medical Devices ● 5 9

— —. . -. . ——————-——

actual price of the equipment. The decision whether

to accept assignment rests with the supplier on

a case-by-case basis.

In addition to being generally inflationary,

Medicare’s CPR pricing system creates particular problems in localities with only one or a few

suppliers of DME. A high-priced supplier with at

least 25 percent of the locality’s market for a particular kind of DME can unilaterally determine

the prevailing charge and thus manipulate its payment rate (237). The only deterrent to such behavior is the 20-percent coinsurance rate, which

may make some consumers sensitive to the price

charged. But in localities with just one or two suppliers, this price sensitivity is bound to be low.

Some observers have noted the potential impact of Medicare’s hospital DRG payment system

on the suppliers of DME (154). Under DRG payment, hospitals have an incentive to become suppliers of services and products that are subject to

less restrictive payment. One potential is for these

institutions to become DME suppliers. Having a

built-in referral base of patients would facilitate

this kind of service integration.

The net effect of competition from hospitals on

DME prices is unknown, but it could conceivably

cause price cutting by freestanding suppliers in an

attempt to maintain their market share. However,

the sensitivity of patients to changes in DME

prices may be low because the effective coinsurance rate for DME in 1977 was estimated at 26

percent (237). Independent suppliers appear to be

concerned about the possible effects of competition from hospitals with a “captive” market (161)

and have suggested that Medicare require hospitals to provide patients with information on independent suppliers.

Payment for Home Health Care Services

Home health care services are defined as services that require professionally trained personnel

(e.g., nursing, physical therapy) and are delivered

to patients in the home. To some extent, home

health care substitutes for institutional care provided in hospitals and nursing homes, but in part

it is also a service that substitutes for care that

would otherwise be provided by family, friends,

or patients themselves. Since medical devices are

commonly used in the delivery of these services,

the recent rapid growth in the use of home health

care services will affect the kinds of devices that

will be demanded.

Although there are no precise data on historical trends in the total use of home health care services throughout the country, data are available

for use by Medicare and Medicaid beneficiaries.

From 1974 to 1982, the number of home health

visits to Medicare beneficiaries increased by 247

percent, from 8.1 million visits in 1974 to 28.1

million visits in 1982 (159). In the same period,

Medicare reimbursements to home health agencies—organizations that provide home health care

services—grew from 1.2 to 2.5 percent of total

Medicare reimbursements, or $1.2 billion in 1982.

Approximately 4 percent of those reimbursements

were for equipment, appliances, and nonroutine

supplies offered as part of home health care visits

(136), and 28 percent can be attributed to nonlabor costs (310). Medicaid expenditures for home

health services were almost $500 million in 1982

(399).

Table 21 estimates national home health care

expenditures by source in 1981. Since the data

underlying these estimates are imprecise, the table

should be considered only as a general description of the relative importance of various funding sources. Almost 60 percent of home health

care expenditures are paid for directly by patients.

Medicare and Medicaid account for another 19

percent of such expenditures, and private insertable 21.—Estimated Home Health Care

Expenditures and Percent

Distribution by Source, 1981

. . ——

Dollar amount Percent

— (billions) ——— . of total

Patient direct payments . . . . . . $3.8 58.5%

Medicare . . . . . . . . . . . . . . . . . . . 0.9a 13.9

(Federal) . . . . . . . . . . . . . . . . . .

(State) . . . . . . . . . . . . . . . . . . . 0 . 3 (3.1)

Other government . . . . . . . . . . . 4.6

Private health insurance . . . . . 1.1b

16.9b

Philanthropy . . . . . . . . . . . . . . . . 0.1 1.5

——..—..—.

Total . . . . . . . . . . . . . . . . . . $6.5 100.00/0

~rhls (S an understatement because it includes approximately one-tenth Of

t?xpend It ures provided through hospital-based home health care services.

bA proxy was used for expenditures for “home health Care.” The proxy used,

reimbursement for “other payment services;’ generally reflects government and

patient direct payments for home health care, but may not accurately reflect

private health insurance coverage, which is probably much lower than the 16.9

percent Indicated in the table.

SOURCE R M. Gibson and D. R. Waldo, C

’National Health Expenditures, 1981:’

Health Care Finan, Rev. 4(1):1-35, September 1982
60 • Federal Policies and the Medical Devices Industry — . — ——

ance for less than 17 percent. These data are for

1981, before expanded Medicare home health

benefits as mandated by the Omnibus Budget

Reconciliation Act of 1980 (Public Law 96-499)

were implemented. Medicare’s share of home

health care expenditures may have increased since

then.

The number of home health agencies has grown

dramatically in the past 3 years alone. Table 22

shows the number of Medicare-certified home

health agencies by type in 1979, 1981, and 1982.

Substantial growth occurred in the number of proprietary agencies serving Medicare patients. Part

of the reported growth between 1981 and 1982

does not represent development of new agencies

but is an artifact of the liberalization of Medicare’s

policy regarding certification of proprietary agencies that went into effect in October 1981 pursuant

to the Omnibus Budget Reconciliation Act of

1980. But even between 1979 and 1981, when proprietaries were unable to participate in Medicare

in certain States, the number of these agencies

serving Medicare patients grew by almost 75

percent.

Medicare will pay for home health services to

patients who are homebound, under the care of

a physician, and requiring part-time or intermittent skilled nursing care or physical or speech therapy. There are no deductibles or coinsurance required of the beneficiary, and since 1980, there

are no limits on the number of visits the beneficiary can receive during any year. Medicare reimburses home health agencies on a reasonable cost

basis, much the same as the Medicare inpatient

hospital reimbursement method prior to the introduction of DRG payment. In the recent past,

attempts to control Medicare outlays for home

health services have centered on two strategies:

1) tight control over eligibility for home health

care services, and 2) imposition of per-visit limits

on rates of reimbursement to home health agencies.

To be eligible for home health care benefits, the

patient must require “intermittent” skilled nursing care. The definition of skilled nursing care

depends on the licensing requirements of the individual States; usually it means a person with

a Registered Nurse or Licensed Visiting Nurse or

equivalent degree, The definition of “intermittent”

has been the major avenue for control. HCFA has

recently interpreted it to mean a requirement for

up to two or three visits per week and less than

8 hours in any one visit. Daily visits by a skilled

nurse are reimbursed only if a physician affirms

that such frequent visits will not be necessary for

more than 2 or 3 weeks (74). The idea is that if

a patient needs daily care, he or she should be in

a skilled nursing home, even if the person would

prefer to stay at home, because it is less expensive (162).

Medicare does not provide home health care

benefits to patients who receive total parenteral

or enteral nutrition therapy at home. But, since

1 977, Medicare has covered these services under

its prosthetic device benefit (Part B), which covers all nutrients, equipment, and supplies. HCFA

has interpreted the prosthetic device benefit as requiring the patient to have severe and permanent

impairment and as not covering the nursing servTable 22.—Medicare-Certified Home Health Agencies by Type of Agency

———

December -

September December

Type of agency 1979 1981 1982

Visiting nurses association . . . . . . . . . . . . .

511 . - -—.—

513 517

Combination (government/voluntary) ... , 50 55 59

Government . . . . . . . . . . . . . . . . . . . . . . . 1,274 1,234 1,211

Rehabilitation center based , . . . . . . . . . . . . NAa

11 16

Hospital based . . . . . . . . . . . . . . . . . 349 432 507

Skilled nursing home based . . . . . . . . . . . . NAa

10 32

Proprietary . . . . . . . . . . . . . . . . . . . . . 165 287 628

Private nonprofit . . . . . . . . . . . . . . . . . . . . . 44.3 547 632

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66 — —.

38 37 .

aNA indicates information not available; hwne agencies in these ategories were classified as “other” in 1979.

SOURCES 1979 data: U.S Department of Health and Human Se vices, Health Care Financing Administration, Off Ice of

Research and Demonstration, Medicare: Use of Home 1~ea/th Serv/ces, 1980, prepared by Kathryn D. Barrett, July

1983 draft 1981, 1982 data: Home Hea/fh Line,

28, Feb 4 1983

“Char) ~lng Face of Medicare Home Health” (table), VOI Vlll, p.
Ch. 3—Payment Policies for Health Care and Medical Devices ● 6 1 ——— —.-. — —

equipment and supplies, and also discriminate

against patients requiring home health care as well

as nutrition services (153). (See box F for a description of the parenteral and enteral nutrition

market. )

Control over rates of reimbursement to home

health agencies was initiated in 1981 (310) and

tightened again in 1981 and 1982. The control was

in the form of limits on per-visit routine costs of

home health agencies. At present, all home health

agencies are subject to a per-visit limit set at the

75th percentile of costs of freestanding agencies,

weighted by the mix of visits made (skilled nursing, physical therapy, home health aids) and the

urban or rural location of the agency. The cost

of medical equipment, appliances, and supplies

that are not routinely furnished in conjunction

with patient care visits are not subjected to the

limits.

The reimbursement limits have several inherent

incentives. The most obvious is for the home

health agency to “unbundle” its supplies from

routine categories to nonroutine categories, which

are not subject to payment limits. The second is

to substitute nonroutine equipment, appliances or

supplies for routine nursing or other services

whenever possible. Third, the agency has no incentive to consider price in decisions to purchase

nonroutine items. The ultimate effect of these

limits is probably to increase the use and cost of

medical devices in home health care.

 that are routinely furnished in conjunction with patient care visits and are directly identifiable services to

an Individual patient must meet the following criteria: 1) the common and established practice of home health agencies in the area

is charge separately for the item; 2) the agency follows a consistent charging practice for both Medicare and non-Medicare patients

receiving the item; 3) generally, the item is not frequently furnished

to the patient; 4) the costs can be identified and accumulated in a

separate cost center; and 5) the item is furnished at the direction

of the patient’s physician and is specifically identified in the plan

of treatment (310).
62 ● Federal Policies and the Medical Devices Industry
Ch. 3—Payment Policies for Health Care and Medical Devices ● 6 3

THE FINANCIAL RELATIONSHIP BETWEEN

THE THIRD-PARTY PAYER AND PROVIDERS

The vast majority of health care services in the

United States are delivered by private providers—

hospitals, physicians, and other professionals and

institutions—who are organizationally and financially independent of the third-party payer. As

discussed above, these providers bill either the patient, the third-party payer, or both and are paid

some proportion of their costs or charges, depending on the payment methods and policies of the

third-party payer. This fee-for-service system pays

providers more when more services are delivered.

Except for those services whose level of payment

is below their cost,15 the provider- iS financially

rewarded by providing more services. Although

the third-party payer can attempt to control the

use of services through regulatory means, such

15T’here are SeVera ] reasons why the lev~’1 <lt payment might be

below the cost of providing a service t) ,i ~lven patient. First, the

cost of providing the service might vary t andomly around some

mean level, thus leading to losses on some p~tients which are made

up for by profits on others. Second, the service might be a “lossIeader, ” deliberately priced low to enc(~ur,ige utilization of other,

more profitable services. Third, the prov]der may be required to

offer some services below cost as a conditl ~n for providing others

to a third-party payer’s beneficiaries>

as I utilization review, the provider has a general

incentive to deliver more individually billable

services.

There are two exceptions to this fiscal independence of payer from provider. First, for health service: that are provided directly by the government

in publicly owned and operated facilities, the

payer and provider are integrated in the same entity. The VA’s system of hospitals, nursing homes,

and outpatient clinics is an example of an integrated health care system that is relatively closed

and publicly funded and operated. Second, a

small but growing proportion of the population

is enrolled in per capita insurance plans.

Public Systems

Whether the patterns of use of health care services and hence, of the devices on which many

of them depend are substantially different in publicly operated and budgeted facilities is a matter

for empirical investigation. There is some circumstantial evidence suggesting that the rate of adoption of certain new medical devices has been
64 • Federal Policies and the Medical Devices Industry

— — —- —.—— —— —— — —.———— ——

slower in VA hospitals than in the civilian health

care sector, but differences between public and

private administration confound the comparison.

VA hospitals adopted CT scanners much more

slowly than other hospitals of comparable size.

In 1980, almost 85 percent of all community hospitals of 500 beds or more had at least one CT

scanner, whereas only 25 percent of VA hospitals of comparable size had adopted CT scanning

(349).” In the remaining hospitals, the VA contracted with civilian hospitals for provision of CT

procedures.

The rate of use of therapeutic apheresis also appears to be substantially lower in VA hospitals

than in the civilian sector, although no comparisons by type of patients treated are available to

pursue the reasons for the difference (350). A

study conducted in the early 1970s of hospitals’

adoption of respiratory therapy techniques and

electronic data processing found that Federal hospitals adopted these technologies more widely

than non-Federal hospitals, but the study did not

control for hospital size, the population served,

and other important differences between Federal

and non-Federal hospitals (187). (Federal hospitals on average are much larger than non-Federal

hospitals.)

Per Capita Payment Systems

The second exception to the fiscal independence

of payer and provider covers a small but growing proportion of the population (5.8 percent in

January 1984 (170)) enrolled in health maintenance organizations (HMOs). For a fixed per capita payment, HMOs provide comprehensive but

specified covered medical services through a defined

set of physicians and hospitals (346). An HMO

may either employ or contract with physicians to

provide the covered services. If the relationship

is contractual, it may be on a basis other than simple fee-for-service. Although an HMO may own

its hospital, almost all contract with selected hospitals and other facilities to provide services to

their enrolled members. Since the HMO must

compete with other insurers, it has an incentive

to keep premiums competitive with them. HMOs

lbMost VA medical centers, for example, include chronic care beds,

whereas most community hospitals do not.

are also organizationally well suited to limiting

costs by controlling the use of covered services.

There is strong evidence that enrollees of prepaid group practices, a type of HMO organized

around a medical group practice, have lower rates

of hospitalization than other plans. In a review

of HMO experience, Luft concluded that enrollees

in prepaid groups had about 30 percent fewer hospital days, mainly because of lower admission

rates rather than shorter lengths of stay (198). But

studies of HMOs organized around contracts with

independent physicians, frequently referred to as

individual practice associations (IPAs), do not

support the contention that these have lower

hospitalization rates when differences among patient characteristics are considered (346). In general, IPAs and other HMOs appear to have lower

rates of surgery than fee-for-service plans (346).

The lower rates of hospitalization in prepaid

groups would, of course, lower the use of medical supplies and equipment in the hospital. Surgical supplies and equipment, in particular, would

need to be bought less frequently under an HMO

payment system. Of course, to some extent reductions in the use of hospital devices may be

accompanied by more intensive use of deviceembodied procedures during ambulatory care

visits,

The net effect of these shifts has not been studied, but it is likely that the direct impact of HMOs

to date on the medical devices industry or any

of its segments is probably small .17 Although the

competitive effect of HMOs on the behavior of

other private insurers could reduce the rate of use

of health services more generally in the community, particularly in those metropolitan areas

where HMOs have a significant share of the insurance market, there is no convincing evidence

that such an effect has occurred (198). This result is not surprising considering that HMOs, as

well as other plans, have been operating in an

environment where the buyers of health insurance

---- .—

“AS of January 1984, 5.8 percent of the civilian population was

enrolled in HMOS, and in 1981, about 84 percent of HMO enrollees

were In prepaid group practices (170). If prepaid group practices

account for a 30-percent reduction in days of stay per capita, the

existence of prepaid group practices is responsible for at most a reducti{~n of 1..s percent in total patient days.
Ch. 3—Payment Policies for Health Care and Medical Devices ● 6 5

. .

and medical care are insulated from market pressures to be efficient.

The appeal of HMOs and other prepaid plans

is that they hold promise for more careful assessment of all inputs into the production of health

care services, including devices. HMOs have incentives to provide care in the most efficient and

cost-effective manner, using the best mix of resources to accomplish that purpose. But there are

also pitfalls. HMOs have an incentive to enroll

healthy members of the population whose medical care is less costly to provide. Such practices

also have a financial incentive to provide as few

services as possible to their enrollees. As long as

HMOs exist in an environment in which they must

compete for members, however, the tendency

toward underprovision of services maybe limited.

DISCUSSION AND POLICY OPTIONS

This chapter has examined the relationship of

third-party payment, particularly Medicare, to the

overall size of the medical devices market and the

kinds of medical devices that are likely to be

bought and used. In the traditional fee-for-service

sector of U.S. health care, the decision to cover

a particular device and the methods used to determine the amount of payment appear to influence the demand for devices.

The methods used to determine levels of payment for devices or device-embodied medical services have influenced their adoption and use in

ways that will increase society’s cost without adequate concern for benefits. In particular, the reasonable charge approach used by Medicare for all

Part B services creates problems in several areas.

With physicians’ services it tends to favor new

device-embodied procedures over traditional technologies and office visits, with inadequate regard

for their relative cost effectiveness. For laboratory

testing, the CPR mechanism tends to encourage

laboratory testing in physicians’ offices. And for

durable medical equipment, suppliers with a high

share of the market may be able to manipulate

payment rates.

Although cost-based reimbursement of hospitals is being largely discarded by Medicare, and

may soon disappear for other payers as well, the

continuation of cost-based reimbursement of hospital capital tends to favor medical equipment

over other kinds of resources used in the delivery of hospital services. In addition, the cost-based

system continues to apply to Medicare home

health services, creating incentives to use medical devices (as well as other inputs to home health

services) that may be socially inefficient. Although

Medicare has instituted limits on per-visit costs,

they do not include nonroutine supplies, equipment, and appliances provided as part of a physician’s plan for home health services. Thus, there

are additional incentives for home health care to

become too device-intensive over time.

It appears that the manufacturers of medical

devices may be responsive to changes in thirdparty payment policy, particularly Federal payment policy, in the kinds of devices that are made

and the prices at which they are sold. Even in concentrated markets, such as that for hemodialyzers,

manufacturers appear to have been responsive to

market pressures by reducing prices or improving products to enhance their productivity (260).

The recent introduction of Medicare’s DRG payment system may lead to substantial changes in

the kinds of devices that are marketed to hospitals. The ultimate impact of these changes on the

total market for medical devices is, of course,

unknown—as are their ultimate effects on the

quality and costs of medical care.

The problems discussed above can be addressed

on a piecemeal basis by altering details of thirdparty payment methods, or they can be addressed

by broader reforms of the payment system. The

options discussed in this section begin with those

addressing specific issues raised in four areas of

payment: clinical laboratory services, home health

services, physicians’ services, and hospital services. Options related to more fundamental changes

in the health care payment system are then discussed
66 ● Federal Policies and the Medical Devices Industry

— ———. —— . — .

Payment for Laboratory Testing

Physicians have financial incentives to order

and perform clinical laboratory tests in their offices. The solution to this situation is the development of payment methods with neutral financial incentives for physicians to order diagnostic

procedures and to select the least costly settings

of test performance.

Option 1: Mandate that Medicare establish a laboratory fee schedule with mandatory assignment for all providers.

Medicare’s new fee schedule for laboratory

services lowers Medicare’s payment for tests, but

it may strengthen physicians’ financial incentives

to conduct laboratory tests in their own offices,

even when office tests are more costly than tests

sent to independent laboratories.

A fee schedule system that on the one hand requires mandatory assignment of laboratory claims

by physicians and on the other allows the physician to bill for services even when they are provided by outside laboratories would give physicians a financial incentive to perform their own

laboratory tests only when the tests are less costly

to perform in the office than in an outside laboratory.

The fee schedule could be based on the price

typically charged by laboratories to physicians.

This price is usually competitive, especially in

metropolitan areas.

This option would eliminate incentives to perform tests in physicians’ offices when they are

more costly than sending them out, but it would

not necessarily eliminate the financial incentive

that physicians have to increase test ordering. If

the physician must accept assignment, whether

a test is profitable will depend on the difference

between the fee allowed by Medicare and the

lowest cost at which the physician can provide

the service. Careful and constant attention would

need to be given to the relationship between prices

of tests and efficient production of laboratory

services because some tests will continue to be

profitable and others may become profitable as

new technologies reduce laboratory costs.

Option 2: Mandate that Medicare experiment with

other alternatives to the reasonable charge

method for clinical laboratory services.

A national fee schedule is just one of the alternatives to the reasonable charge methodology for

clinical laboratory services. For example, competitive bidding, negotiated rates of payment, and

master contracts have been discussed or implemented by State Medicaid agencies. At present,

there is insufficient evidence to assess which of

these or other approaches is the most effective approach to purchasing laboratory services for

Medicare beneficiaries.

The 1981 Omnibus Budget Reconciliation Act

(Public Law 97-35) authorized States to enter into

competitive bidding or other similar arrangements

to procure laboratory testing for Medicaid populations. A State must demonstrate that laboratory

services will be adequate, that selected laboratories will be Medicare-certified, and that no more

than 75 percent of the business of the winning laboratory is reimbursed by Medicare and Medicaid.

To date, only Nevada has implemented competitive bidding for laboratory services (120).

California is considering development of a

“master contract” with terms spelled out and reimbursement rates set. The contract would be offered to any licensed or certified laboratory wishing to provide services to California Medicaid

enrollees.

HCFA has had under consideration several

demonstration projects to test varying methods

of laboratory reimbursement. HCFA plans to test

four different procurement approaches through

demonstration projects: payment rates established

by negotiation with laboratories; fee setting by

HCFA without negotiation; competitive bidding

with laboratories eligible to provide services as

long as they agree to accept the price of the winning bid; and competitive bidding with only winning bidders eligible to provide Medicare testing.

Currently, HCFA is awaiting the report of a contractor for design of a competitive bidding methodology (120). It remains to be seen whether the

demonstration will actually be undertaken.

The Administration has proposed legislation to

authorize the Secretary of Health and Human
Ch. 3—Payment Policies for Health Care and Medical Devices ● 6 7

— ——— . — —--——

Services to purchase Medicare laboratory services by competitive bidding, negotiated payment

rates, or exclusive contracts with laboratories (S.

643, H. 2576). Because little is known about the

feasibility or impact of these approaches, it seems

premature to engage in them on a nonexperimental basis.

Payment for Devices Used in the Home

Medicare reimburses for medical devices used

in the home through the durable medical equipment benefit (Part B), the prosthetic devices benefit (Part B), and the home health services benefit (Parts A and B). ” There are several problems

in existing payment methods that may affect the

kinds of devices that are used and the prices at

which they are offered. Moreover, lack of coordination among these benefit categories creates

anomalies in payment for different patients using

the same devices.

Option 3: Mandate that Medicare include in pervisit payment limits on home health services

the cost of nonroutine equipment and supplies.

Cost-based reimbursement of home health care

services creates problems of inflation and inappropriate use of all inputs, including devices. For

this reason, Congress has authorized DHHS to

limit per-visit rates of reimbursement for routine

services to the 75th percentile of the costs of freestanding agencies (those not affiliated with institutions) in similar circumstances. At present, however, the cost of medical equipment, appliances,

and supplies that are not routinely furnished in

conjunction with patient care visits are not subject to the the limits. This exclusion creates incentives for agencies to “unbundle” their supplies

from routine categories to nonroutine categories

and to substitute nonroutine equipment, applileThe MediCare Program has two parts: Part A, the Hospital Insurance program; and Part B, the Supplementary Medical Insurance plan. Part A’s primary purpose is to provide protection against

the costs of inpatient hospital care. Other Part A benefits include

posthospital extended care services, home health services, and inpatient alcohol detoxification services. Part B services include physician services, outpatient hospital services, outpatient physical therapy, and other ambulatory services and supplies, such as prosthetic

devices and durable medical equipment. Part B also covers home

health services for those Medicare beneficiaries who have only Part

B coverage (345).

ances, or supplies for routine nursing or other

services whenever possible. Moreover, a home

health agency has no incentive to consider price

in decisions to purchase nonroutine items.

Integrating nonroutine items into the per-visit

limits would eliminate these problems, but it

would also increase the already existing incentives

for home health agencies to select as clients patients whose need for such items is relatively low.

Without a reliable measure of case severity, the

potential for such patient selection strategies

would probably be high. Therefore, an important

priority for research would be development of a

patient classification system for home care similar to the DRG system used for hospitals. Even

then, there is the question of whether home health

agencies are large enough to spread the risk of

enrolling patients with high equipment needs

across a large enough pool of patients.

Option 4: Encourage Medicare to experiment with

alternatives to reasonable charge reimbursement

of durable medical equipment (DME).

As with other Part B services, the use of reasonable charge screens—maximum limits on the

amount Medicare will pay based on comparative

profiles of suppliers’ actual charges—for DME

probably raises the prices paid for such equipment. Medicare’s CPR pricing system for DME

creates particular problems in localities with only

one or a few suppliers of DME, where a highpriced supplier with at least 25 percent of the

locality’s market for a particular kind of DME can

unilaterally determine the prevailing charge and

thus manipulate its payment rate.

Possible alternatives to the CPR pricing system

would be national or regional price ceilings and

competitive bidding by suppliers. As yet, there

is no experience with either of these approaches,

so it is unknown how they would affect the availability or prices of DME. Price ceilings based in

the beginning on regional or national average

prices and adjusted for general inflation over the

years would tend to raise prices charged by lowpriced suppliers while at the same time lowering

those of high-priced suppliers. It might also reduce the access of Medicare beneficiaries, particularly those with low incomes, to DME if assign-
68 ● Federal Policies and the Medical Devices Industry

. —

ment rates were to drop as a consequence of the

ceilings or if suppliers in high-cost localities were

to find it unprofitable to serve Medicare beneficiaries.

Unless this approach were adopted in conjunction with a requirement that suppliers of DME

beneficiaries accept assignment or elimination of

the 20-percent coinsurance requirement for those

accepting assignment, the drop in assignment rates

would cause part of the burden of expenditure to

shift from Medicare to the beneficiary.

Competitive bidding by suppliers would be

most useful in areas with a reasonably large number of potential suppliers. The details of a competitive bidding strategy are important in determining the effect on availability and prices of

DME. One approach would be a Medicare requirement that all DME rentals or purchases in

a locality be made through the two or three lowbidding suppliers. This approach would probably

be successful in driving down prices in the near

term, but it has certain drawbacks. First, the bidding would have to be on a product-by-product

basis, and it would be impractical to require a beneficiary to use a different supplier for each device

bought. Second, the approach could lead to a reduction in the number of suppliers, with consequent increases in prices by remaining suppliers

in subsequent years.

The effect of any of these approaches on the

price and availability of DME to Medicare beneficiaries could be studied in the context of demonstrations or experiments.

Option 5: Extend Medicare home health benefits to individuals on parenteral or enteral nutrition.

Medicare currently refuses to provide home

health care benefits to patients who receive at

home total parenteral or enteral nutrition therapy—methods of direct feeding through the bloodstream or gut. Since 1977, Medicare has covered

these services as a Part B benefit under prosthetic

devices. HCFA has interpreted the prosthetic device benefit as applying only to patients with permanent impairment and as excluding any nursing services. However, as part of training and

adjustment for home parenteral and enteral nutrition, nursing services may be required. Patients

must receive these services at outpatient departments for nursing services to be reimbursed.

The effect of this regulation is to limit parenteral

and enteral nutrition benefits to ambulatory patients with permanent need for the technology.

It might be possible to shift patients out of hospitals into home care settings if these restrictions

were lifted. However, if home health benefits were

extended to patients receiving parenteral and

enteral nutrition, the current 20-percent coinsurance rate would no longer apply because home

health services (Part A) do not entail coinsurance,

and Medicare would bear the full burden of expenditure. To avoid this added cost to Medicare,

Congress could authorize DHHS to maintain the

relevant equipment and supplies costs as prosthetic devices under Part B, while offering home

health benefits under Part A. Patients receiving

such services would then be required to copay for

the Part B portion but not for the home health

services.

Payment for Physicians’ Services

Medicare and some other third parties pay for

covered physicians’ services on a reasonable charge

basis. These systems, based as they are on profiles of physicians’ charges, tend to have an inflationary effect on physicians’ fees because each

physician’s future payment is tied through the fee

screen to currently billed charges. In addition,

these systems put a premium on the performance

of new procedures for which comparative fee

screens have not been established. The physician

can charge a high fee for a new procedure and

have it reviewed for its reasonableness by a medical review committee composed primarily of

practicing physicians. After these fees are established and comparative fee screens are developed,

the new procedures remain highly rewarded relative to old procedures.

The Federal Government could adopt for Medicare, Medicaid, and CHAMPUS several options

for physician payment to address these problems.
Ch. 3—Payment Policies for Health Care and Medical Devices ● 6 9

—.——.—. . — — — —

Option 6: Mandate that Federal insurance programs adopt fee schedules that change the relative prices of new v. old procedures and devicebound v. cognitive procedures.

The objective of developing fee schedules that

change relative prices is not to discourage the introduction of new devices, but to remove the present financial incentives to select one procedure

over another (239).

Implementation of this option would require

collection of data on the costs of performing both

new and old procedures in order to establish relative prices. It would also require a system for

monitoring cost changes in procedures as they diffuse into the practice of medicine (140). Moreover,

it is not clear that relative costs are the most

appropriate basis for relative prices. Prices should

reflect the relative values of procedures, but because of present distortions in the pricing system,

it would be difficult to identify differences in these

relative values. Hence, setting relative fees would

require making judgments about technologies,

specialties, and classes of medical care because

relative fees affect their use.

How would relative price schedules be affected

by voluntary assignment as now exists under

Medicare? Voluntary assignment effectively turns

a fee schedule into a benefit schedule. A fee schedule limits the amount actually received by the provider, whereas a benefit schedule limits the amount

that will be paid by the insurer. Under a fee

schedule, the insurer pays only the stated price

for a procedure and requires the provider to accept that price as payment in full or not be paid

for the service at all. Under Medicaid’s mandatory

assignment system, a relative price schedule would

be a fee schedule. With voluntary assignment,

however, the physician could collect the difference

between the billed charge and Medicare’s payment

from the patient, rendering the payment limit a

benefit schedule.

To some extent, then, a benefit schedule that

paid relatively less for services associated with

medical devices and more for cognitive services

would result in Medicare patients’ paying a greater

share of the costs of medical devices. Since people generally use fewer services the greater the

level of cost-sharing, the relative use of medical

devices would be expected to fall somewhat, but

the extent of this effect is unknown.

Option 7: Mandate that Federal insurance programs pay physicians by episode of illness or

by person served rather than by procedures or

services delivered.

Just as DRG hospital payments provide incentives for hospitals to treat each hospital case in

the least costly manner possible with the least

costly mix of devices and other inputs, payment

for ambulatory physicians’ services by the episode

or case would offer similar incentives to physicians. In particular, the financial incentives to provide more laboratory tests and other devicebound procedures than is cost effective would be

eliminated.

However, this approach would not only eliminate financial incentives to perform specific procedures, since each procedure performed would

reduce physicians’ net incomes. Whether physicians would actually respond to those financial

incentives is unknown. Underprovision of laboratory and other device-bound procedures would

be a possibility in some cases and would require

monitoring.

This option would also require development of

new systems of classifying patients according to

medical conditions, complaints, or health status.

Otherwise, people with serious conditions and

higher use rates might gravitate to certain providers and overburden them financially (“adverse

selection”), or some providers might try to attract

people considered less costly to treat (“creamskimming”). At present, the technology of patient

classification does not appear to be well developed in the ambulatory care area.

One way to begin implementing this option

would be to focus on physicians’ services to hospital inpatients. Physicians could be paid a specific fee based on the patient’s diagnostic category

for the entire hospital stay, rather than for each

inpatient visit. This arrangement would provide

financial incentives to reduce the number of physician visits to the hospital and, as a consequence,

the number of procedures ordered. However, even

this limited use of per-episode physician payment

would be difficult to implement soon. First, a
70 ● Federal Policies and the Medical Devices Industry

classification system appropriate to physicians’ inputs has not been developed, and the validity of

DRGs as a classification system for physicians has

not been tested; second, physicians’ claims data

are not organized in a way that readily allows estimation of the relative use of physician service by

inpatients in different diagnoses.

The development of adequate patient classification systems to support payment on a basis other

than fee-for-services is expensive, and individual

payers have little incentive to support such research. As it has in the past, the Federal Government through HCFA could take the lead in supporting research in this area.

Hospital Payment

Medicare’s new DRG payment system establishes a different set of incentives for hospitals.

These incentives represent an improvement over

the previous cost-based reimbursement system because, unlike the old system, they encourage hospitals to treat each inpatient case in the least costly

manner possible. Of course, the DRG system is

new and hardly complete; further modifications

in its administration can be expected. One such

modification with particular relevance to medical devices is the treatment of capital costs. The

current system leaves capital costs (depreciation

and interest19) reimbursed as they are incurred,

with no limit on the amount that a hospital can

be paid. In conjunction with fixed payment for

most other components of inpatient costs, this approach encourages investment in medical equipment and facilities relative to personnel and supplies, which are controlled.

Option 8: Amend the Social Security Act to include payment for capital in DRG payment

rates.

The fundamental issue under the newly created

Medicare DRG payment system is whether a hospital’s capital payment should or should not be

subject to some kind of externally imposed limit.

The current passthrough reimbursement of capital could continue as a permanent feature of DRG

Igcapita] cost also includes a payment for return on equity, but

only to proprietary hospitals.

payment. Alternative methods of capital payment

that impose limits on reimbursement fall into three

categories: 1) those that establish uniform rates

of payment across all hospitals (or all within a

class); 2) those that establish hospital-specific

limits to capital payment; and 3) those that condition payment on approval of capital expenditure projects.

The uniform payment approach would treat all

hospitals alike, regardless of their capital or operating expenditures. Uniform payment could be

calculated either as a fixed percentage of the DRG

price or as a flat rate per bed. Hospital-specific

approaches, on the other hand, would take the

hospital’s capital or operating costs into account

in establishing a level of payment, but limit increases in the payment level over time. Thus, for

example, capital payments could be limited to a

percent of operating costs, so that hospitals with

high operating costs would receive a higher capital payment than others; alternatively, the capital payment in any year could be tied to the hospital’s actual capital costs (as measured by interest

and depreciation) in a base year with adjustments

for inflation in subsequent years.

If capital payments were controlled through direct regulation of capital expenditures, only projects approved by a certificate of need (CON) or

other designated agency would be recognized by

Medicare for capital payment. Approved projects

would then be paid on a cost basis. Areawide or

statewide annual capital expenditure limits could

be used to establish an upper bound on the value

of approved projects. The State of New York is

currently considering adoption of such a capital

expenditure limit (38).

The alternative capital payment methods described above can be evaluated on the basis of

four general criteria:

●

●

●

Efficiency—the extent to which the approach

promotes the cost-effective use of hospital

devices.

Equity of access to medical technology—the

extent to which the method promotes equal

access among population groups to capitalembodied medical technology.

Fairness—the extent to which the method

treats all kinds of hospitals alike, neither
Ch. 3—Payment Policies for Health Care and Medical Devices ● 7 1

rewarding nor penalizing hospitals for conditions outside their control.

● Feasibility—the extent to which the method

is administratively workable and politically

acceptable.

As discussed above, a permanent capital cost

passthrough under DRG payment violates the efficiency criterion, because it distorts incentives for

hospitals to adopt and use capital-embodied devices. However, this approach does well on the

other three criteria. Its feasibility has been demonstrated through the years. It is inherently fair because all hospitals face the same rules regarding

capital payment. Finally, it poses no barriers to

equal access to medical technology, although it

does nothing to redress current inequities.

Any of the three controlled payment methods

described are more efficient than passthrough capital payment, because the hospital is encouraged

to provide its care at the least possible cost. New

medical devices would be judged in terms of their

impact on total costs, not just on operating costs.

Hospitals would be further encouraged to specialize and join in plans for regionalization of health

services. However, it is difficult to devise a controlled payment system that is fair to all hospitals. In a uniform payment system, hospitals that

in the past have had lower ratios of capital to

operating cost would receive more than they had

in the past, while those with high ratios would

receive less.

A uniform rate of payment would also create

a difficult and possibly costly transition if hospitals that have made major investments in recent

years or anticipate them in the near future are not

to be unduly penalized. The American Hospital

Association has recently proposed a uniform capital payment system that would pay each hospital the higher of cost-based reimbursement or a

fixed payment rate during a 10-year phase-in

period (8). Anderson and Ginsberg have suggested

a less generous transition in which “budget neutrality” is maintained by gradually reducing the

proportion of the capital payment that is a passthrough (14).

Tying capital payment to the level of capital

costs in a base year or to the hospital’s operating

costs is efficient but may be unfair This kind of

. 

system tends to reward those hospitals who were

most capital-intensive in the past, leaving those

with low levels of capitalization forever to receive

lower payments. Moreover, it would not work

well for hospitals requiring major capital expenditures in the early years of implementation. Perhaps for these reasons, support for this approach

has been limited to movable equipment, which

typically has shorter lifetimes and lower variations

in asset values among hospitals.

Hospital capital has two components: the fixed

plant and equipment constructed with the facility (new hospital, addition, renovation), and the

movable equipment placed in the facility. All

capital-embodied medical devices fall into the

movable equipment category. The useful lives of

movable equipment are usually relatively short

(5 to 10 years) and most, but not all, individual

equipment purchases are much smaller than the

costs of construction. Therefore, it is possible and

perhaps even prudent to consider these two classes

of capital separately.

Two States, New Jersey and Maryland, have

included in their prospective per-case payment

systems controls on major movable equipment expenditures (345). In the case of Maryland, the hospital’s current value of undepreciated equipment

in a base year is built into the controlled hospital

rates, with adjustments only for inflation in subsequent years. 20 In New Jersey, the amount allowed

for major movable equipment is determined by

a blend of the hospital’s own current value of

undepreciated equipment and the average current

value of undepreciated equipment in similar hospitals in the State.

inclusion of major medical equipment in the

DRG payment prices would encourage hospitals

to consider the cost of such equipment in decisions about the most appropriate mix of resources.

It would probably require a transition phase for

new (and newly equipped) hospitals, but the

length of the transition could be short due to

the short useful lives of the equipment in this

category.

‘OExceptlons can be negotiated with the State’s Health Services

~’o~’ RevI~t\ ( ‘ommission.
72 • Federal Policies and the Medical Devices Industry

It is difficult to predict the effects of direct regulation of capital expenditures through CON or

other agencies. Direct regulation can occur with

or without statewide or areawide maximum limits

on total capital outlays over a given period, and

the effects can be expected to differ between the

two. Although there has been much discussion in

certain States about establishing actual expenditure limits or “pooling” capital, all experience to

date has been with CON and section 1122 programs that do not operate with areawide or statewide limits. The experience with capital expenditures regulation in the absence of such limits has

been disappointing, with most evaluations concluding that the level of capital expenditures has

not been affected (61,63,247,436). Moreover, the

distribution of medical technologies among hospitals does not appear to have improved as a result of CON (61).

There is no evidence, either theoretical or empirical, to suggest that the outcome of an annual

limit on the level of capital expenditure process

would be either efficient or fair (447). A review

of the literature on resource allocation decisions

by committees revealed that the ultimate outcomes depend on chance and on the composition

of the committee and the procedures governing

the decisionmaking process (447). Moreover, the

kinds of information needed to make informed

tradeoffs among competing capital projects is

likely to be unavailable, thus leaving the process

even more exposed to political solutions.

Regardless of whether or not an areawide limit

is applied, direct regulation of capital expenditures

is administratively feasible only for large projects

—construction and renovation projects and major new services. The current trend toward high

thresholds for capital expenditure controls (453)

would probably continue, leaving an ever larger

proportion of capital-embodied technology to be

controlled in some other way.

Systemwide Reforms

All of the options discussed above involve specific adjustments to a payment system that has

two fundamental problems: first, the more units

of service that are offered, the more the Provider

is paid, resulting in greater use of the medical services, including devices; and second, the more restrictive one part of the payment system becomes

relative to others, the greater is the incentive to

shift the settings of service delivery from the more

restrictive to the less restrictive ones.

When financial incentives are inconsistent with

cost-effective adoption and use, regulatory approaches can be attempted, but they are often unwieldy. For example, the regulatory process of

coverage for medical devices creates differential

barriers to the introduction of new devices that

have little to do with their effectiveness or cost

effectiveness. Despite this fact, the sheer size of

the task of individually reviewing each medical

device for its efficacy and safety (not to mention

cost effectiveness) in each potential use as a precondition to coverage argues against the development of such a coverage process. Instead, the

difficulties inherent in the coverage process outlined in this chapter seem to support the development of payment methods that create incentives

for individual providers or users to make decisions that are consistent with the goals of the

Medicare program.

Option 9: Encourage Medicare to move toward

payment for medical care (including devices)

on u per capita basis.

One remedy for the problems of the current system may be the adoption of per capita payment,

in which a set of defined and reasonably comprehensive services is offered in exchange for a

fixed premium. Under per capita arrangements,

such as those offered by HMOs, all resources used

to produce health services are subject to the same

constraints, and incentives exist to select the least

costly mix of resources.

Per capita payment has two potential problems,

however, which suggest that careful assessment

be given to this alternative. First, there is the possibility under these plans that people with the

greatest need or demand for medical care will enter specific plans and that other plans will selectively enroll low users, leading to unequal cost

burdens among alternative plans. Varying the

amount of the payment by the age or existing

health status of the beneficiary would address this
Ch. 3—Payment Policies for Health Care and Medical Devices ● 7 3

— —.

problem, but it is difficult to identify factors that have a financial incentive to provide too few.

will be associated with greater medical care need. However, competition among plans and the costs

Second, just as fee-for-service medicine gives pro- of malpractice insurance may limit this risk of

viders an incentive to provide too many services, underprovision.

providers of services on a per capita basis would

25-406 0 - 84 - 6
4

Research and Development;

Policies Related to

Medical Devices

Columbus may have been impelled by a desire for spices, but it was the

supply of corn which was increased

—Kenneth J. Arrow
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

Trends in Medical Devices R&D . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78

Sources of Support for Medical-Device-Related R&D . . . . . . . . . . . . . . . . . . 79

Federal Support for R&D on Medical Devices . . . . . . . . . . . . . . . . . . . 79

Private Sources of Funds for R&D on Medical Devices . . . . . . . . . . . . . . . . . . 80

The Small Business Innovation Research Program . . . . . . . . . . . . . . .. 86

Federal Support for Orphan Devices. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88

State and Local Initiatives Related to R&D for Medical Devices . . . . . . . . . . . . . . 91

Discussion and Policy Options. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

LIST OF TABLES

Table No. Page

23. Industrial R&D in Five SIC Medical Devices Codes, 1974-80 . . . . . . . . . . . . . . 79

24. Sources of Support for Industrial R&D in Five SIC

Medical Devices Codes, 1974-80. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79

25. R&D Grants and Contracts Awarded by the National Institutes of

Health, Fiscal Year 1982. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 80

26. Sources of Financial Capital to Firms in IRS Category 3845:

Optical Medical, and Ophthalmic Goods, 1976-80 83

27. Sources of Financial Capital to Firms in IRS Category 3698:

Other Electrical 1976-80 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

28. Sources of Financial Capital to Firms in IRS Category 40:

All Manufacturing, 1976-80, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

29. Capital Commitments to Independent Private Venture

Capital Funds, 1979-82 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

30. Percentage of Types of Venture Capital Financing in Medical Devices

and Other Fields, 1982 . . . . . . . . . . . . . . . . . . . . . 86

31. Analysis of Applications for Small Business Innovation Research (SBIR)

Grants, National Institutes of Health, 1983.. . . . . . . . . . . . . . . . . . . 88
Research and Development Policies

Related to Medical Devices

INTRODUCTION

New medical devices arise from a process of research and development (R&D)—purposeful activities requiring the investment of time and other

economic resources in the investigation of scientific or technical problems. R&D is frequently

classified into three phases:

●

●

●

✎

Basic research—original investigation whose

objective is to gain fuller knowledge or understanding of the fundamental aspects of

phenomena and of observable facts without

specific applications in mind (421).

Applied research—investigation whose objective is to gain knowledge or understanding necessary for determining the means by

which a recognized and specific need may be

met (421).

Development—systematic use of the knowledge or understanding gained from research

in the design and development of prototypes

and processes (413).

Investment in R&D, particularly in development, is a necessary, but not sufficient, condition

for technological progress’ in medical devices.

Some new devices may result from sudden insights, with little developmental work needed;

others may require a laborious and slow development phase with high levels of investment. All

new devices (or device improvements) need some

level of development and possibly research. Yet

there are no guarantees that greater investment

in R&D will lead to higher levels of technological progress in a field. The productivity of R&D

depends to a 1arge extent on the present state of

scientific knowledge (413) and to some extent on

the existence of a “product champion” (413), but

‘Technological progress is defined here as the continual introduction to practice of new and more useful ways of serving human purposes (262).

it may also depend on how the R&D is organized:

who performs it, who funds it, how funding decisions are made, and the social and economic structure in which it occurs.

The purpose of this chapter is to examine Federd R&D policy as it relates to medical devices.2

As in other areas of Federal policy, questions of

R&D policy transcend the medical devices field.

Federal stimulation of industrial R&D through direct subsidies or indirect policies (e. g., tax policy) has been a national concern (67,70). Similarly, Federal support for basic research and

training as a long-term national investment in

technological change and R&D capacity has been

discussed widely in general terms (280) and in

terms of biomedical research as a whole (413).

This discussion will concern itself neither with

the broad issues of R&D policy nor with public

policy instruments that cannot be readily targeted

to specific fields such as medical devices (e.g., the

use of income and corporate tax incentives to

stimulate R&D). It is important to note, however,

that global R&D strategies may have an impact

on the level, directions, and settings of R&D on

medical devices that is as great or greater than

the impact of R&D strategies directed specifically

at medical devices. (App. G contains an analysis

of the impact of recent changes in Federal tax policy on medical devices R& D.)

To address the specific issues pertaining to R&D

for medical devices, the chapter first presents data

on expenditures for and performance of medicaldevice-related R&D. The chapter also analyzes

sources of support for medical-device-related

R&D. The concluding section of the chapter discusses problems that have been identified and policy options to address them.

.— —— — R&D in the Veterans Administration is discussed in ch. 7.

77
78 • Federal Policies and the Medical Devices Industry

TRENDS IN MEDICAL DEVICES R&D

For two reasons, it is difficult to identify and

quantify R&D activities specifically related to

medical devices. First, most basic and some applied research lays the scientific foundation for

a wide range of future products and processes,

including medical devices, without being specifically attributable to a device or even to a class

of devices. Second, the R&D data that are published are either aggregated or classified in a manner that is inconsistent with the definition of medical devices used in this report. The picture of

device-related R&D must be sketched from disparate and only partially relevant data sources.

Annual estimates of the level of health-related

R&D expenditures in the United States are available from the National Institutes of Health (NIH),

but these estimates are not broken down by phase

of R&D and are not specific to medical devices.

In 1980, health R&D totaled an estimated $7.89

billion, of which 28 percent was performed, and

31 percent was funded, by industry (404).3

Annual estimates of R&D conducted by medical device companies are available from the National Science Foundation (NSF) survey of R&D

in industrial firms, but their validity as estimates

of industrial R&D on medical devices is somewhat

limited. The NSF’s estimates of company-wide

R&D for firms whose primary line of business is

one of the five medical device Standard Industrial

Classification (SIC) codes4 overestimate industrial

R&D on medical devices to the extent that the

medical device companies conduct R&D in other

product categories and underestimate it to the extent that R&D for medical devices is conducted

by firms classified in other SIC codes. Because

many medical devices firms are owned by large

multiproduct firms, s 

— the balance is likely to be

3 —

The NIH estimates of industrial R&D for health are imprecise

and probably underestimated due to limitations of the data on which

the estimates were based (449).

‘The five medical devices SIC codes are: 3693 (X-ray and electromedical equipment), 3841 (surgical and medical instruments), 3842

(surgical appliances and supplies), 3843 (dental equipment and supplies), and 3851 (ophthalmic goods) See ch. 2 for further information on the SIC codes.

‘Three obvious examples are the General Electric Co., with extensive R&D in medical imaging; E. I. du Pont, with R&D in healthrelated products; and Johnson & Johnson, Inc. r a drug company

with several device subsidiaries. (Because Census Bureau data are

confidential, it is impossible to state with certainty the severity of

the classification problem. )

toward underestimation of industrial R&D on

medical devices.

NSF’s estimates of company-wide expenditures

for applied research and development are broken

down into general product categories such as

professional and scientific instruments” and “other

electrical machinery equipment and supplies. ”

These categories are too broad to allow the extraction of applied research and development expenditures that pertain specifically to medical

devices. Basic research expenditures are collected

for the company as a whole and are not broken

down by product class.

These caveats must be recognized in interpreting table 23, which presents estimates of industrial R&D expenditures aggregated over the five

medical devices SIC codes. In the 1974-80 period,

industrial R&D expenditures, which include both

company and Federal funding, grew at an average annual rate of 16.1 percent in the five medical devices SIC codes, as compared with an annual growth rate of 11.7 percent in industry as

a whole (422,424). It is also interesting to note

that although R&D expenditures for medical devices are probably underestimated, in 1980, industrial R&D expenditures for firms in the five

medical devices SIC codes were equal to 3 percent of the value of such firms’ shipments (see

table 23); in industry as a whole, R&D expenditures were equal to 2.4 percent of the value of

shipments (422,424).

The data suggest that the medical devices industry is relatively R&D-intensive. In 1980, for

firms in the five medical devices SIC codes, company-sponsored R&D was equal to 2.9 percent of

the value of such firms’ shipments; for industry

as a whole, company-sponsored R&D expenditures amounted to only 1.6 percent of the value

of shipments (422,424). For the rate of company

Investment in basic research, there is little difference between medical devices firms and industry as a whole. In 1979, firms in the five medical

devices SIC codes reported that 3.7 percent of

their company-sponsored R&D was basic research, while the figure for industrial firms as a

whole was 4.1 percent (422,424).
Ch. 4—Research and Development Policies Related to Medical Devices ● 79

.—. —.. .-——

Table 23.—industrial R&D in Five SIC Medical Devices Codesa, 1974-80 (dollars in thousands)

Basic Percentage Applied Percentage Percentage Not Percentage Percentage of

Year research of total research of total Development of total identified of total Total shipments

1975::: NA NA NA NA NA NA NA NA 168,884 2:9

1974 2 ’0/0 25 1°/o 70.60/o 1.7% 2.8 %

1976 . . . 6,234 3.1 33,046 16.6 90,957 45.8 68,637 34.5 198,874 3.0

1977 . . . 8,406 3.7 65,994 28.8 154,277 67.5 NA NA 228,677 2.8

1978 . . . NA NA NA NA NA NA NA 273,794 3.0

1979. . . 11,272 3.8 67,968 23.3 188,690 6 4 7 23,821 8.2 291,751 2.8

1980 . . . NA NA NA NA NA NA NA NA 348,707 3.0 — —

NA indicates information not available because of issues of confidentiality

aThe five Standard Industrial Classification (SIC) code medical devices categories are

SIC 3693: X-ray and electromedical equipment

SIC 3841: Surgical and medical instruments

SIC 3642: Surgical appliances and supplies

SIC 3843: Dental equipment and supplies

SIC 3851: Ophthalmic goods

SOURCES U S Department of Commerce, Bureau of Industrial Economics, 1983 U.S /ndustr/a/ Ou(/ook, Washington, DC, January 1983; US. National Science Foundation “Survey of Industrial Research and Development, ” conducted by the U S Bureau of the Census, 1982

SOURCES OF SUPPORT FOR MEDICAL-DEVICE-RELATED R&D

R&D for medical devices takes place in numerous settings—private companies, hospitals, and

university and government laboratories. The

sources of support for these activities are highly

varied. It is impossible to isolate the sources of

funding of medical-device-related R&D performed

in academic or government laboratories from

those for other health or general R&D, but data

are available on the sources of funding of medical devices R&D conducted in industry. b

Table 24 shows the sources of support for industrial R&D in the five SIC medical devices codes.

The level of support from NIH and other Federal

agencies is substantially lower for industrial R&D

in these SIC codes than it is for industrial R&D

as a whole. In 1980, the Federal Government

funded less than 3 percent of the R&D conducted

by firms in these SIC codes, compared with 29

percent of R&D conducted by industry as a whole

(422).

Federal Support for R&D on

Medical Devices

The Federal Government supports over 52 percent of total health R&D, most of it (70 percent)

through grants and contracts from NIH (404).

Table 25 shows the distribution of R&D grants

and contracts awarded by NIH in fiscal year 1982.

cThe limitations of the NSF industrial R&El survey apply in interpreting these data, however.

Table 24.—Sources of Support for Industrial R&D

in Five SIC Medical Devices Codesa

, 1974-80

——— —

Percent

Total change in

industrial companyR&D Federal Company sponsored

——— Year (thousands of dollars) R&D .

1974. . $142,080 $3,635 $138,445 —

1975. . 168,884 164,006 18.5%

1976. . 198,874 5,464 193,410 17.9

1977. . 228,677 5,727 222,950 15.3

1978. . 273,794 5,623 269,171 20.7

1979. . 291,751 4,788 286,963 6.6

—1980. . — . — 348,707 7,125 341,582 19.0

aThe five slc codes we the same as those listed in table 23.

SOURCES U S Department of Commerce, Bureau of Industrial Economics, 1983

U S /rrdustria/ Out/ook, Washington, DC, January 1983; U.S. National

Science Foundation, “Survey of Industrial Research and Developmerit, ” conducted by the U.S. Bureau of the Census, 1982.

Industry received approximately 6 percent of total

NIH grants and contracts for that year. (Of course,

these grants and contracts encompass much more

than the development of medical devices, including some basic research, drug and biotechnology

development, and procurement of items such as

research laboratory equipment. )

Despite the small proportion of NIH funds that

goes to industry, NIH and other agencies’ support

for R&D in specific medical device areas is probably sizable in absolute terms. The National Institute for Handicapped Research’s Rehabilitation

Technology program, for example, administers

a $9 million annual program of grants and con-
80 ● Federal Policies and the Medical Devices Industry —

tracts to 18

Table 25.—R&D Grants and Contracts Awarded by

the National Institutes of Health (NIH), Fiscal Year 1982

‘Total amount Percentage of

Performing institution — —-——— — (thousands of dollars) total

Domestic institutions . . . . . . . . . . . . . . . . . . . . . . $2,709,248 990/0

Nonprofit. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,558,010 94

Higher education . . . . . . . . . . . . . . . . . . . . 2,025,822 74

Medical schools . . . . . . . . . . . . . . . . . . . . 1,412,540 52

Government . . . . . . . . . . . . . . . . . . . . . . 40,656 1

Federal . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2,083 0

Research institutes . . . . . . . . . . . . . . . . 470 0

Hospitals. . . . . . . . . . . . . . . . . . . . . . 404 0

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,209 0

State and local . . . . . . . . . . . . . . . . . . . . . . 38,574

Research institutes. . . . . . . . . . . . . . . . 1,774 1

Hospitals. . . . . . . . . . . . . . . . . . . . . . . . . 26,362 1

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10,438 0

Other nonprofit . . . . . . . . . . . . . . . . . . . . 491,531 18

Research institutes . . . . . . . . . . . . . . . 275,575 10

Hospitals. . . . . . . . . . . . . . . . . . . . . . . . 163,188 6

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52,768 2

Profit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151,238 6

Foreign institutions . . . . . . . . . . . . . . . . . . . . . . 22,820 1

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $2,732,068 100%a

apercentage may not sum to 100 because Of rounding errors

SOURCEU S.Department of Health and Human Services, National institutes ~fHealth, Offlceof Program Plannlng and Evaluatlon and the Dlwslon of Research Grants, NIH Data Bock 1983 Washington, DC, June 1983, table 17

centers engaged in applied research

and development of rehabilitative-devices (299).

NIH’s critical role in supporting the development

of renal dialysis technology is described in box G.

A recent analysis of NIH, NSF, and Department

of Energy grants and contracts active as of May

1983 revealed that almost $50 million was related

to diagnostic imaging (460). This medical imaging R&D was scattered throughout the institutes

and agencies and covered a wide assortment of

subjects including not only development or refinement of new imaging devices, but the use of imaging techniques to enhance understanding of disease processes. A high proportion of these grants

went to academic and other nonprofit institutions,

and therefore supplemented the R&D on medical imaging conducted by industry. NIH funding

in the medical imaging area has, in retrospect, had

important impacts on the later development of

commercial imaging devices. Box H presents the

history of Federal funding for research on nuclear

magnetic resonance (NMR) imaging.

Private Sources of Funds for R&D on

Medical Devices

How do medical device firms go about financing the R&D that is not supported by direct grants

and contracts? Firms have two potential sources

of financing: retained earnings and the financial

capital markets. If funds are sought from external sources, they may be generated either through

debt or equity instruments. Tables 26, 27, and 28

present data on the sources of financial capital to

firms in three Internal Revenue Service (IRS) industry categories:

• optical, medical, and ophthalmic goods (IRS

3845);

● other electrical (including but not limited to

X-ray and electromedical devices) (IRS 3698);

and

● all manufacturing (IRS 40).

These industry classifications include a substantial number of firms not engaged in the production of medical devices, and the data pertain to
Ch. 4—Research and Development Policies Related to Medical Devices ● 81

. .- —. —

the financing of all activities in these fields, not

just the financing of R&D and innovation. Consequently, the interpretation must proceed with

caution.

Table 26 shows that in 1980, external equity

became a very important source of financing for

small firms in the optical, medical, and ophthalmic goods category. Retained earnings have consistently been less important to firms in this category than they are to manufacturing firms as a

whole. The shift by small firms in the optical,

medical, and ophthalmic goods category toward

external equity may be the result of the infusion

of large amounts of venture capital into new companies in this area in 1979. Notice also that small

optical, medical, and ophthalmic goods companies depend to a greater extent on all forms of

external financing than do large firms in the same

Industry.

The role of venture capital in financing innovation i n general and new medical devices in particular has increased dramatically since 1978. Venture capitalists are investors who specialize in

providing financial capital to small and, sometimes, new firms. From 1969 to 1977, the total

venture capital pool in the United States remained

virtually unchanged, at the level of about $2.5 billion to $3 billion (190). Since then, however, the

total venture capital pool has increased sharply,

reaching between $3.5 billion and $4 billion in

1979 (441), $5.8 billion in 1981 (442), and an estimated $7.5 billion as of December 1982 (440).
82 • Federal Policies and the Medical Devlces Industry —

Ikw H.—Federal Funding of Research on Nuclear Magnetic Rewwance hnagir@

Guvermmmt policies related to of medical device research and dew%pnwnt (R&0) by universities and rnamda~turers car-i have impacts on the evolution of technokgy and the shape of

particular device industries. The h!story of Governrnent funding of Nh4R imaging research in the United

States reflects these impacts.

NMR imaging is an exciting new diagnostic imaging modaIity that has captured the interest of the

medical profession. R has many desirable attributes, including the use of mdiowaves and powerful

magnetic fiekk rather than ionizing radiation. It also offers excelkmt tissue contrast without the need

for injection of potentially toxic contrast agents and allows visualization of areas such as the posterior

fcwm, brain stern, and spinal cord, which are not well seen with other imaging techniques. Finally, the

technique offers the possibility & detecting diseases at earlier stages than is currently possible and of

permitting accurate pathologic diagnoses to be made nonirwasively.

NMR also has disadvantages. NMR irnagers are expensive and logistically difficult to install. They

may also require more physician time in perkrmance of patient exmninaticm than do-computed tomography (Cl”) or other imaging techniques. Moreover, at this time, the exact sole of NMR imaging in clinical medicine, particularly its efficacy compared to other imaging modalities, has yet to be defined.

Over the past decade, the National Institutes of Health (NIH) has supported research relating to

NMR imaging, biomedical appkcations of NMR parameters, and biomedical applications of NMR spectroscopy. Although NM km provided some funds for development and use of software and ancillary

hardware, it has not provided, and dues not plan to provide, support to clinkal or research hmtitutiorts

to lx wed either to develop or purckw N&II? imaging machines for use in human imaging.

NIH has had an active intramural prwgrarn of research involving applications of NMR for many

years. over the past 6 years, Dr. David Fkx&, a physicist and ektrcmics engineer, has cunchxted research

focusing on NMR imaging and techniques. Dr. Robert Ek&ban has Txwn studying

physiological appkatiams of phosphorus, sodium, and nitrogen Ni%@ for the past 3% years.

Also, a research group has been formed by Dr. Charles Meyers of the National Cancer Institute (NCI)

to expke tk use of NMR in the study of the metabolism of bath mwmal and cancer cells as well as

the effect of various drugs on cellular me&dmlisrn. The group will akm be exploring possible applications

of NM? to the study of (62).

Using funds contributed by several institutes, NM has purchased a Nh4R imaging system

on which it will perfmm clinical studies including investigations of disease, the effects

of chemotherapy and radiation therapy on Nh4R parameters, and whether NMR can be used to predict

patients’ respcmses to chemotherapy and radiation therapy.

NII-I has also engaged in active extramural support of NMR irna@ng. a few of the NA4Rrelated extramural grants have been fumkd by the National Heart, Lung, and Blood Institute (NHU31)

and other institutes, most of them have been funded by NCI. The first eximmm.rd NCI grant related

to NMR imaging was awarded to Paul Lauterbur at the State University of New York-Stony Brook in

1973 after publicatkm of a landmark article on NMR (191). The award was made to help Lauterbur

further develop his techniques of NR4R imaging and investigate its to cancer research. His

initial funding of appmximate~y pm year for 3 years has been renewed at an approximately

constant level, without interruption, since 19!73. Lauterbur alsu received ~ ~ant km NHLBI in 1975

related to the use of NMR imaging to study blood flow and ari additicm~l per year from that

institute since 1978. NIH also supported early work on NhlR of sw@dly excised human

tumors (76,77} and tumors in mice and rats (M4,152), as well as on the imaging d tumors in live animals

(75).

NIH is cwmdy funding approximately $2 million of research to l%lkll? imaging or in vivo

spectroscopy in at least 10 diffarent (460). The Of Ene~w kas a~~ded an addi -

tional $%.8 million for NMR-rektted rewarch (46U). In October 1962, the EMagmstk Imaging Research
Ch. 4—Research and Development Policies Related to Medical Devices ● 8 3

..- . —

Table 26.—Sources of Financial Capital to Firms in IRS Category 3845: Optical, Medical,

and Ophthalmic Goods, 1976-80 — .— .-.——. —.

Asset size class (000s) Asset size class (000s)

Ratio $1-$5,000 $5,000+ Ratio $1-$5,000 $5,000+ ——.

External equity to assets

.—

1978 . . . . . . . . . . . . . . . . 0.2 0 0.16

1980 . . . . . . . . . . . . . . . . . . . . 0.38 0.18 1977 . . . . . . . . . . . . . . . . 0.20 0.14

1979 . . . . . . . . . . . . . . . . . . . . 0.16 0.19 1976 . . . . . . . . . . . . . . . . . . . 0.12 0.13

1978 . . . . . . . . . . . . . . . . . . . . 0.23 0.18 Short-term debt to assets

1977 . . . . . . . . . . . . . . . . . . . . 0.24 0.20 1980 . . . . . . . . . . . . . . . . 0,20 0.17

1976 . . . . . . . . . . . . . . . . . . . . 0.26 0.23 1979 . . . . . . . . . . . . . . . . . . 0.24 0.13

Retained earnings to assets 1978 . . . . . . . . . . . . . . . . . . 0.22 0.16

1980 . . . . . . . . . . . . . . . . . . . . 0.08 0.35 1977 . . . . . . . . . . . . . . . . . . 0.17 0.17

1979 . . . . . . . . . . . . . . . . . . . . 0.16 0.37 1976 0.20 0.15

1978 . . . . . . . . . . . . . . . . . . . .

.,.. ,.

0.14 0.39 Trade debt to assets

1977 . . . . . . . . . . . . . . . . . . . . 0.21 0.40 1980 . . . . . . . . . . . . . . . . 0.18 0.17

1976 . . . . . . . . . . . . . . . . . . . . 026 0.40 1979 . . . . . . . . . . . . . . . . . . 0.13 0.15

Long-term debt to assets 1978 . . . . . . . . . . . . . . . . . 0.17 0.12

1980 . . . . . . . . . . . . . . . . . . . . 0.14 0.13 1977 . . . . . . . . . . . . . . . . . 0.13 0.09

1979 . . . . . . . . . . . . . . . . . . . . 0.27 0,17 1976 . . . . . . . . . . . . . . . . . 0.18 0.09

.——————.———. . —.— —

SOURCE: U.S. Department of the Treasury, internal Revenue Service, Sourcebook of Stdisfrcso f/rrcorne, for years 1976-80, as cited in(26)

Variability in the amount of venture capital in Recent changes have led to a resurgence in the

the United States is influenced by many factors, United States in the supply of venture capital.

including sensitivity to general variables in the Especially important to the supply of venture capoverall economy (e.g., interest rates and infla- ital have been decreases in the rate at which longtion), changes in capital gains tax laws, and changes term capital gains are taxed. In 1978, the rate of

in pension fund investment rules. taxation was reduced substantially; more recently,
84 ● Federal Policies and the Medical Devices Industry

——— .

Table 27.—Sources of Financial Capital to Firms in IRS Category 3698:

Other Electrical, 1976-80

Asset size class (000s)

Ratio $1-$5,000 $5,000-$25,000 $25,000-$100,000 $100,000+

External equity to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Retained earnings to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Long-term debt to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Short-term debt to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Trade debt to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

0.16

0.12

0.20

0.22

0.16

0.16

0.27

0.22

0.19

0.29

0.18

0.13

0.14

0.14

0.11

0.32

0.25

0.22

0.22

0.22

0.19

0.19

0.20

0.21

0.20

0.18 0.14

0.14 0.15

0.17 0.15

0.18 0.14

0.23 0.19

0.33 0.48

0.39 0.42

0.37 0.48

0.40 0.47

0.35 0.45

0.14 0.13

0.13 0.17

0.14 0.13

0.12 0.13

0.13 0.15

0.21 0.15

0.18 0.16

0.19 0.16

0.18 0.16

0.18 0.13

0.16 0.10

0.14 0.10

0.13 0.10

0.12 0.10

0.11 0.09

0.09

0.10

0.12

0.13

0.13

0.22

0.23

0.25

0.25

0.25

0.27

0.28

0.27

0.24

0.28

0.30

0.27

0.25

0.26

0.23

0.12

0.12

0.13

0.12

0.11

SOURCE: U.S. Department of the Treasury, internal Revenue Sewice, Sourcebook of Statistics of/rmorne, for years 1976-80,

as citedin (26)

the Economic Recovery Act of 1981 established

the long-term capital gains tax rate at 20 percent

for individuals and 28 percent for corporations,

making venture investments more attractive than

they hereunder the pre-1978 rate of 49 percent.

Also, in 1979, pension fund regulations of the

Employee Retirement Income Security Act were

interpreted as allowing some pension fund money

to flow into venture capital investments.

The results of these changes are evident in data

presented in table 29, which shows capital cornmitments to private venture capital funds for the

years 1978 to 1982. Not only have the total annual outlays of venture capital funds increased as

a whole, but also the amount available from pension funds has grown dramatically since 1979: in

1982, pension funds represented one-third of the

new capital commitments to private venture capital firms (443).

In 1981, venture capital investments in medical and health-related products and services constituted about 6 percent of investments made in

organized venture capital markets (26). Table 30

shows the 1982 distribution of venture capital investments by stage of investment in four product categories: medical imaging, other medical

products, industrial products, and electronics.

The two medical devices categories—medical

imaging and other medical products—show a relatively high proportion of investments in early

stages, although in medical devices, as in other

fields, the organized venture capital market appears to invest negligible amounts at the earliest

(seed money) stage of development. The relatively

important role of venture capital firms in financing the startup of new medical device firms suggests that investors have been more likely to take

greater risks in this field than they have in other
Ch. 4—Research and Development Policies Related to Medical Devices • 85

Table 28.–Sources of Financial Capital to Firms in IRS Category 40:

All Manufacturing, 1976.80

Asset size class (000s)

Ratio $1-$500 $5,000-$25,000 $25,000-$100,000 $100,000+

External equity to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Retained earnings to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . ,

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Long-term debt to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Short-term debt to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

Trade debt to assets

1980 . . . . . . . . . . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . . . . . . . . . . .

1977 . . . . . . . . . . . . . . . . . . . . . . . .

1976 . . . . . . . . . . . . . . . . . . . . . . . .

0.13

0.13

0.14

0.18

0.16

0.29

0,30

0.28

0.28

0.29

0.18

0.18

0.17

0.17

0.16

0.21

0.21

0.21

0.21

0.20

0.18

0.19

0.19

0.18

0.19

0.13

0.12

0.13

0.15

0.16

0.33

0.34

0.35

0.36

0,35

0.18

0.18

0.16

0.17

0.17

0.21

0.21

0.21

0.19

0.19

0.15

0.15

0.15

0.14

0.13

0.16

0.16

0.17

0.18

0.19

0.33

0.33

0.34

0.34

0.34

0.28

0.20

0.20

0.21

0.20

0.19

0.19

0.18

0.17

0.17

0.12

0.12

0.12

0.11

0.10

0.16

0.16

0.17

0.17

0.18

0.28

0.29

0.30

0.30

0.28

0.25

0.24

0.24

0.25

0.26

0.19

0.18

0.17

0.16

0.15

0.12

0.13

0.12

0.12

0.12

SOURCE: US. Department of the Treasury, internal Revenue Service, Sourcebook of Statistics of/ncorne, for years 1976-80,

as cited in (26)

Table 29.—Capital Commitments to lndependent

Private Venture Capital Funds, 1979-82

1978 1979 1980 1981 1982

Total capital committed (dollars in millions):

Corporations . . . . . . . . . . . $22 $28 $127 $142 $ 175

Endowments and

foundations . . . . . . . . . . 19 17 92 102 96

Foreign investors . . . . . . . 38 26 55 90 188

Individuals and families . . 70 39 102 201 290

Insurance companies.. . . 35 7 88 132 200

Pension funds . . . . . . . . . . 32 53 197 200 474

Total . . . . . . . . . . . . . . . . $216 $170 $661 $867 $1,423

Percentage of total capital committed:

Corporations . . . . . . . . . . . 10% 170/0 19% 170/0 120/0

Endowments and

foundations . . . . . . . . . . 9 10 14 12 7

Foreign investors . . . . . . . 18 15 8 10 13

Individuals and families . . 32 23 16 23 21

Insurance companies.. . . 16 4 13 15 14

Pension funds . . . . . . . . . . 15 31 30 23 33

Total . . . . . . . . . . . . . . . . 100% 100% 100% 100% 100%

SOURCE Venture Economics, Wellesley Hills, MA, ’’Venture Capital Investmentin

the Medical Health Care Field; contract reporl Prepared for the Office

of Technology Assessment, August 1983. See app F for adescriptlon

of the Venture Economics database frcrn which these data were derived.
86 ● Federal Policies and the Medical Devices Industry

 .

Table 30.—Percentage of Types of Venture Capital Financing in Medical Devices and Other Fields, 1982a

Other medical

Type of financing Medical imaging products Industrial products Electronics

Seed money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0% 1% 1% 1%

Startup and first stage . . . . . . . . . . . . . . . . . . . . 57 56 29 35

Expansion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 38 37 58

Leveraged buyouts and acquisitions . . . . . . . . . 0 1 27 1

Other .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 4 6 5

asee ‘PP, F for ~de~~~iption of the venture Economics database from which this table is derived

SOURCE: Venture Economics, Wellesley Hills. MA, “VentureCapital Investment in the Medical Health Care Field; contract report prepared for the Office of Technology

Assessment, August 1983.

fields, even in a traditionally high-technology ing seed money must frequently look to their

product category such as electronics. Yet, these owners’ and friends’ contributions of both time

data also suggest that small and new firms seek- and money. See box I for an example.

THE SMALL BUSINESS INNOVATION RESEARCH

The Small Business Innovation Development

Act (Public Law 97-219), enacted into law in 1982,

requires each Federal agency whose extramural

R&D obligations exceed $100 million to set aside

a small percentage for R&D grants or contracts

with small businesses. NIH’s Small Business Innovation Research (SBIR) budget amounted to

$5.6 million in fiscal year 1983 and $8.2 million

in fiscal year 1984.8 The awards are made in three

phases: Phase I involves small awards of 6 months’

duration for proving the scientific and technical

feasibility of new ideas; Phase II involves further

development of these ideas with the addition of

a plan to acquire non-Federal venture capital in

the subsequent phase; and Phase III involves only

non-Federal capital committed to pursuit of commercial applications (but Federal involvement

may be in the form of agreements to purchase

products).

Each agency may determine the categories of

projects within its SBIR program and has control

over the size of the maximum award in each

phase, the amount of sharing of R&D expenses

required of awardees, and the methods and procedures used to solicit and select among proposals.

Because the SBIR program is specifically targeted

to ideas with commercial promise, the grant awards

‘The percentage increases from 0.2 in fiscaI year 1983 to 1.25

within 4 years.

8NIH actually expended $7.3 million in fiscal year 1983 (425).

are generally skewed

PROGRAM

toward applied research and

development and away from-basic research.

The NIH SBIR program made its first Phase I

awards in October 1983 in the form of grants of

$50,000 in total costs or less. NIH required grantees

to commit to sharing in the costs of the research

and will pay no profit or fee in addition to costs.

An analysis by OTA of NIH SBIR grant applications and awards revealed that an estimated 42

percent of the SBIR applications responding to the

first solicitation were for medical devices (see table

31). No significant differences were found in the

ratio of awards to proposals between medical

devices and other types of research.

It is premature to evaluate the effectiveness of

the SBIR program on small business innovation

in medical devices. Although it is clear that there

has been a reallocation of research dollars from

other R&D programs within NIH to the SBIR initiative, it is unknown to what extent the dollars

have been shifted from research funds that would

have gone to academic and nonprofit institutions

or from research funds that would have gone to

industry anyway. Furthermore, if the shift occurred within industry, it is unknown at this time

to what extent it represents a net transfer of R&D

funds from large firms to small firms or simply

a net redistribution of Federal funds among small

firms.
Ch 4—Research and Development Policies Related to Medical Devices ● 

87

—— - —.. . -— —. .——— . -- - --
88 • Federal Policies and the Medical Devices Industry — —.. —

Table 31.–Analysis of Applications for Small Business Innovation Research (SBIR)

Grants, National Institutes of Health, 1983a

Medical All

Biotechnologyb devices other

applications applications applications

Percentage of total grant applications . . . . . . . . 60/0 420/0 520/0

Percentage of applications receiving awards . . . 21% 230/o 18% . -

aSee app E for estimation methods.

bproposal$ for R & D on medical devices and other technologies using blotectmology.

cProposals for R&D on medical devices not using biotechnology.

dpropo$als for R&D on technologies that neither involve the use of biotechnology nor are medical devices

SOURCE” Off Ice of Technology Assessment

Implementation of the SBIR program may also

affect the productivity of the SBIR program in

stimulating development of new medical devices.

One issue is whether or not the program stimulates those with the best ideas from a commercial perspective to submit grants. It is interesting

to note that in fiscal year 1983, the Department

of Health and Human Services (DHHS) (mainly

NIH) had the lowest ratio of proposals to awards—

six to one—of all Federal agencies. The average

ratio of proposals to awards for Government as

a whole was 11 to 1 (425). Implementation strategies, including the choice of topics included in

the Public Health Service solicitation, the methods used to distribute information on the SBIR

program to small businesses, and policies regarding cost-sharing are likely to have influenced the

proposal rates.

FEDERAL SUPPORT FOR ORPHAN DEVICES

The Federal Government has recently been

charged with the responsibility of identifying and

promoting “orphan products, ” including both

drugs and medical devices. The Orphan Drug Act

(1983, Public Law 97-414) defines orphan products as drugs and devices for rare diseases or conditions. A rare disease or condition is further

defined in the act as one that occurs so infrequently that there is no reasonable expectation

that the cost of developing or making the product for such a condition can be recovered from

sales of the device.

In the case of drugs, the 1983 act authorizes the

Secretary of Health and Human Services to provide four kinds of support for those that have been

found to be orphans:

a 50-percent tax credit on all clinical testing

expenses associated with the drug,

award of an exclusive 7-year right to market a drug that is unpatentable (through the

new drug approval authority of the Food and

Drug Administration (FDA)),

technical assistance in the development of

clinical testing protocols, and

• award of grants and contracts for clinical

testing expenses associated with an orphan

drug. (FDA budgeted $500,000 for this function in fiscal year 1983 and $1 million in 1984

(116).)

These benefits are not available to devices.

The 1983 law also established an Orphan Products Board, with responsibility to “promote the

development of drugs and devices for rare diseases

or conditions . . .,” but its specific functions relate

to drugs alone. Thus, the support of orphan

devices under the new law is largely a conception

rather than a reality. Recently, however, NIH has

become active in supporting R&D on orphan

devices. For example, the National Institute of

Neurological and Communicative Disorders and

Stroke issued a request early in 1984 for proposals

to develop orphan products including drugs,

biological, and devices (403).

The definition of an orphan device as stated in

the 1983 law and in most discussions of the issue
Ch. 4—Research and Development Policies Related to Medical Devices . 89

(115,405) is inadequate because it fails to differentiate between products that are prohibitively

costly but not particularly valuable from those

that are both costly and valuable. Ideally, a device should be considered an orphan when it can

be shown to be:

very valuable to potential users, particularly

in relation to the cost of development, production, and distribution: and

so costly to develop, produce, and distribute that it would be impossible or inequitable to expect potential users to pay a price

that would allow producers to recover these

costs.

To take an extreme example, a lifesaving device whose cost per patient is $100,000 would be

likely to meet the ideal criteria for an orphan device, whereas a $100,000 per-patient device that

improves the quality of life a bit for only a fraction of those who use it probably would not.

Products for rare diseases or conditions frequently (but not always) meet the aforementioned

criteria for an orphan device, because a large part

of the cost of R&D and marketing is fixed regardless of the number of units actually sold. With

fewer potential users over which these costs can

be spread, the price at which the device would

have to be sold is likely to be prohibitive. However, a product for a rare disease that is not particularly valuable to users in relation to its costs

would not meet the two criteria above, though

it would fall into the definition in the act.

There may also be products for relatively common diseases whose costs are still high relative

to patients’ abilities to pay for them. See box J

for a discussion of wheelchairs.

Health insurance, developed as a response to

the disparity between the cost of services and patients’ abilities to pay for them, complicates matters even further. Third-party payment, which

spreads the burden of payment across a broad

pool of individuals, is a mechanism for rendering previously orphaned services and products affordable. Indeed, because health insurance generally reduces patients’ out-of-pocket costs for

health care services, a device whose cost would

normally be prohibitive may have an effective

price well below that level. For example, coronary

artery bypass graft surgery and its related care

were estimated to cost approximately $15, 000 to

$20,000 in 1981 (454). Third parties have paid for

a very large share of these costs, and in 1982, approximately 170,000 bypass operations were performed (401).

Health insurance also forces a redefinition of

the market, because insurers’ decisions about the

coverage of a device and, if covered, the appropriate level of payment become major determinants of patients’ and providers’ abilities to pay

for it. If a service is not covered by health insurance, it may be orphaned; covered and paid for

generously, it is not.

Thus, the definition of an orphan device is inextricably linked to the policies of third-party payers. Whereas drugs, particularly those prescribed

for use outside of hospitals and other institutions,

are poorly covered by health insurance plans (insurance paid only 26 percent of total U.S. expenditures for outpatient prescribed medicines in 1977

(180)), and may therefore occasionally be prohibitively costly to potential users, expensive

devices are, with exceptions, in a more favorable

position. Devices used for diagnosis or therapy

in hospitals, physicians offices, and the home are

generally covered by public and private health insurers.

Coinsurance requirements usually follow those

for other services provided in the same setting.

For example, diagnostic laboratory tests provided

as part of the physician’s office visit typically have

the same coinsurance rate (say, 20 percent) as is

applied to the physician’s own service.

An example of the difference that insurance

payment can make in the definition of an orphan

is the recent characterization of an immunoassay

test for testicular cancer as an orphan by FDA

(205). The test is considered an orphan device because the prevalence of testicular cancer in the

United States is less than 200,000 (116). Yet this

test will probably be covered by third-party payers as a diagnostic service; so it is questionable

whether it actually requires special development

assistance.9

‘FDA has not provided substantial assistance to the developers

of the test (116).

25-406 0 - 84 - 7
90 ● Federal Policies and the Medical Devices Industry

—

Thus, while insurance coverage for the use of ●

diagnostic and therapeutic devices is not complete,

it is generally much higher than for outpatient

drugs. Exceptions to this general rule are:

*

● preventive devices (e. g., screening tests,

home self-testing kits) which are less frequently covered under health insurance plans;

rehabilitative devices, which are often poorly

covered under private and public third-party

payment plans (352); and

devices subject to restrictive third-party payment limits (e. g., some hospital devices under

‘Medicare’s per-case pricing for inpatient hospital care).
Ch. 4—Research and Development Policies Related to Medical Devices . 91 —. —— --- . —

Even in these categories, however, most devices ficiently low price, a large enough market may

will not meet the ideal definition of an orphan. still exist despite poor coverage by third parties.

If they can be developed and distributed at a suf -

STATE AND LOCAL

MEDICAL DEVICES

INITIATIVES RELATED TO R&D FOR

States have increasingly looked to R&D-intensive industries such as medical devices for economic development opportunities. A recent census

of State government initiative for high-technology development conducted by OTA identified

38 programs in 22 States with dedicated” programs of high-technology development (3.53). In

addition, OTA identified 15 “high-technology

education” initiatives, undertaken in conjunction

with State universities and dedicated to providing to inventors and entrepreneurs skills they

need to create firms that will develop or commercialize emerging technologies. Only a few of these

programs actually provided product development

assistance or laboratory or office space for new

and growing businesses.

Perhaps the program most directly relevant to

medical devices is the Health-Care Instrument and

Device Institute (HIDI) at the State University of

New York at Buffalo, which has been designated

by the State of New York as a State-supported

center to facilitate direct interface between academic institutions and the needs of industry (see

box K). Although the HIDI program has several

missions, an important one is to put into practice ideas generated by inventors in the university community (113).

Another popular initiative is the establishment

of a research or science park on or adjacent to

a university campus. These parks are often encouraged by State or local tax incentives, but

many universities have also seen the advantage

of encouraging this type of development. In general, these and other universitv-based initiatives

are seen as a way of providing consulting opportunities for faculty, employment opportunities for

students, and enhanced research funding for the

university. Rensselaer Polytechnic Institute, for

example, has provided incubator space for entrepreneurs who need assistance to start a busi-
ness (354). Several other universities also provide

incubator space for students, including Georgia

Tech, Carnegie-Mellon University, Massachusetts

Institute of Technology, and the University of

Missouri (which also provides commercialization

assistance to students. ) While some of these centers

also assist qualifying small businesses, their major emphasis is on the enterprising student (354).

University-based programs such as these have

been criticized for drawing faculty away from the

conduct of more basic research in favor of applied

research and development. There is also the related issue of maintaining free and open commucessful commercialization requires shielding a

potential product from a firm’s competitors, as

well as obtaining proprietary rights to the invention. To some extent, these requirements conflict

with the ideal of freedom of expression in academic environments. Nor has it been documented

that the resources provided by university-based

centers are addressing the specific barriers to commercialization faced by small or new firms. Since

most of these projects are relatively new, it is not

possible at this time to evaluate their effects either

on innovation or on the quality and quantity of

basic research.

nication within the research community. SucDISCUSSION AND POLICY OPTIONS

Is the current level of Federal and industry support for R&D related to medical devices adequate?

Federal support for industrial R&D can be viewed

as supplementing private firms’ activities in ways

that advance the public good. Federal support is

justified when private firms are not likely to

engage in as much R&D as is socially desirable.

Basic research has long been recognized as being particularly subject to underfunding by private firms (56,228,230). To be efficient, basic research should embody as few constraints as possible

on research directions and be subject to wide disclosure of research results. These conditions conflict with the ability of private firms to reap the

full benefits of their investment in basic research

(230). Hence, private firms are likely to underinvest in basic research, and Federal support may

be necessary.

As R&D projects are more closely targeted to

products or processes with commercial potential,

however, the argument in favor of Federal support becomes weaker. The private medical device

firm is likely to be able to appropriate more fully

the benefits of its investment in R&D the closer

the project is to a commercializable device. And

as research becomes more targeted and specific

to a device, the societal gains from full disclosure

of research findings decline.

Two conditions suggest that the present level

of private R&D for medical devices is generally

adequate. First, if industrial R&D responds to the

demands of the market, as has been suggested by

several observers (273,276), then the high level

of demand for medical devices resulting from

health insurance and other third-party payment

for health care would argue that medical devices

R&D has been adequately, perhaps more than

adequately, stimulated. Second, the $5.4 billion

Federal investment in health R&D (404) provides

a rich and continuing source of new scientific

knowledge that creates opportunities for development of new medical devices.

Against this positive picture for R&D on medical devices is the potentially deleterious effect of

premarket regulation on the cost and uncertainty

of investment in R&D for new medical devices.

A Louis Harris survey reported that because of

FDA regulations, 27 percent of responding firms

stated that they would not consider developing

a new Class III device10 and another 11 percent

stated that they would be unlikely to consider any

device development (197).

‘oA new Class 111 device must be approved by FDA as safe and

effective prior to marketing (see ch. .s).
Ch. 4—Research and Development Policies Related to Medical Devices ● 9 3

However, the available evidence seems to suggest that, except perhaps for small firms and manufacturers of Class III devices, the medical devices

regulations as they have been implemented have

not added substantially to the cost of development, because the vast majority of devices introduced since the passage of medical device regulations in 1976 have not been required to undergo

rigorous premarket testing (see ch. 5 for details).

However, firms have been subject to some uncertainty about how the regulations would be applied.

The Federal Government has recently embarked

on a new strategy—the SBIR program—that does

not increase overall R&D budgets but instead

shifts the allocation of health R&D funds from

other uses to the program’s recipients (small

firms). The NIH SBIR budget is likely to come

at least partially from funds that would otherwise

be used for basic research and would go to nonprofit institutions. Therefore, the program probably results in a small net shift of health R&D

funds toward the development of medical devices.

It is impossible to know whether this shift is in

the best interest of society. Given that the SBIR

program will consume an increasing proportion

of NIH grant and contract funds in the future,

continuing scrutiny of the program’s grant solicitation and selection methods is advisable.

There are specific areas where increased targeted Federal support of R&D on medical devices

may be justified. True orphan devices—those

meeting the dual criteria of high per-unit cost of

development and distribution relative to potential users’ ability to pay and high value in relation to cost—are by definition worthy of support.

However, it is difficult to differentiate between

devices that lack a sufficient market because those

who value them highly cannot afford them and

devices that lack a market because their extra

benefits to society do not outweigh the costs of

bringing them to market. Sound criteria for identifying devices meeting the ideal definition of orphan have not been developed either in the law

or in regulations.

The problem of orphan devices may grow as

pressures to contain health care costs lead thirdparty payers to develop increasingly restrictive

payment policies. Because the definition of a true

orphan device is inextricably linked to the policies of major third-party payers regarding coverage and levels of payment, criteria for identifying orphan devices will have to take these payment policies into account.

There appear to be sound theoretical reasons

for supporting development of devices meeting

the ideal definitions of orphan: high value in relation to cost and high per-unit cost of development

and distribution relative to potential users’ ability

to pay. Whether in practice there are many devices that meet this definition, however, has not

been investigated.

One way to assist the development of orphan

devices, apart from providing direct Federal grants

and contracts for R&D, would be to amend the

Orphan Drug Act (Public Law 97-414) to make

orphan devices eligible for the tax credits and

grants offered under that act. The act currently

provides a 50-percent tax credit for all clinical

testing expenses associated with an orphan drug

and authorizes the Secretary of Health and Human

Services to make grants for clinical testing. It is

important to recognize, however, that the currently inadequate definition of orphan products

in the law, which depends on the “rare disease”

criterion to identify orphan drugs, may encourage

devices that are not worth their costs to society

to be designated as orphans. Thus, it would probably be premature to change the law until criteria

and methods of analysis are developed that will

allow for adequate differentiation between devices

that lack a market because they are truly orphaned

and those that are simply not worth their costs

to society.

Option I: Mandate that DHHS develop criteria

and methods for identifying true orphan

devices.

This option would be particularly useful now,

when Medicare is implementing restrictive new

payment policies in hospitals and changes in physician payment are being contemplated. Without

adequate methods for assessing the extent to

which a given device meets criteria for orphanhood, decisions about R&D subsidies (either
94 ● Federal Policies and the Medical Devices Industry

through direct grants or tax subsidies) for orphan such criteria and methods would probably require

device development are unlikely to be appro- participation of a number of constituent agencies

priate. of DHHS, including FDA, NIH, and the Health

Because the criteria for orphanhood go well Care Financing Administration.

beyond issues of safety, effectiveness, and disease

incidence to payment issues, the development of
5.

Regulation of Medical Devices by

the Food and Drug Administration

Hearts will never be practical until they can be made unbreakable.

—The Wizard of Oz
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

Legislative History of Device Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

The Medical Device Amendment of 1976. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Implementation of the Medical Device Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Registration of Firms and Listings of Devices . . . . . . . . . . . . . . . . . . . . . . . . . . .

Premarket Notification. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Classification of Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Reclassification of Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Good Manufacturing Practices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Performance Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Investigational Device Exemptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Premarket Approval. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Postmarketing Surveillance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Other Provisions of the Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Discussion and Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Scope of Medical Device Regulation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Regulation of Preamendments Class III Devices

and Their Postamendments Equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Regulation of Intermediate Classes of Devices . . . . . . . . . . . . . . . . . . . . . . . . .

Postmarketing Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Impact of the Amendments on Medical Devices Firms . . . . . . . . . . . . . . . . . . . .

Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Scope of Medical Device Regulation, . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Regulation of Preamendments Devices

and Their Postamendments Equivalents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Regulation of Classic, or intermediate, Devices . . . . . . . . . . . . . . . . . . . . . . .

Postmarketing Monitoring and Controls . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Assistance to Small Manufacturers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

LIST OF TABLES

Table No.

32. Number of ’’510k” Submissions and Number Found Not

Substantially Equivalent 1976-83 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

33. Classification of Preamendments Device Types by

Medical Specialty Category, February 1984.. . . . . . . . . . . . . . . . . . . . . . . . .

34. Classification Status of Preamendments Device Types,

February 1984... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

35. Number of Postamendments Class III Devices Found

Substantially Equivalent to Preamendments Devices

by Medical Specialty Category, 1976-83 ..,.. . . . . . . . . . . . . . . . . . . . . . . . . .

36. Investigational Device Exemptions (IDEs) for Significant Risk Devices

by Medical Specialty Category, 1977-82. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

37. Approved Premarket Approval Applications (PMAAs)

by Medical Specialty Category, 1977-82 . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

FIGURES

Figure No.

1. How To Get to Market With a Medical Device . . . . . . . . . . . . . . . . . . . . . . . . .

2. U.S. Patent Applications for Low-Technology Medical Devices, 1968-79 . . .

3. U.S. Patent Applications for High-Technology Medical Devices, 1968-79 . . .

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5.

Regulation of Medical Devices by

the Food and Drug Administration

INTRODUCTION

The Medical Device Amendments of 1976 (Public Law 94-295) consolidated and expanded existing Federal authority over medical devices into

a system of regulating the safety and effectiveness

of medical devices in proportion to the degree of

risk that they pose. In the past 2 years, interest

in the law has grown because of problems that

have surfaced in implementing some key provisions and because of concerns regarding the costs

of some provisions relative to the incremental

gains in safety and effectiveness.

The Subcommittee on Oversight and Investigations of the House Committee on Energy and

Commerce held hearings on the Food and Drug

Administration’s (FDA) implementation of the

statute in July 1982 (336) and issued an oversight

report in 1983 (338). The General Accounting Office also reviewed implementation of the Medical Device Amendments and issued its report in

September 1983 (331). Most recently, in February

1984, the Subcommittee on Health and the Environment of the House Committee on Energy and

Commerce held oversight hearings on the law and

its implementation (337). These hearings and investigations have focused on FDA’s priorities and

pace in implementing the amendments and on

those provisions of the law which, in view of the

experiences gained since the law’s enactment, have

not worked as intended.

The 1976 law, its history, its implementation

by FDA, and key unresolved issues are addressed

in this chapter. The chapter concludes with a presentation of a range of options addressed to the

major objectives of the law.

LEGISLATIVE HISTORY OF DEVICE REGULATION

Medical device regulation was first authorized

in the Federal Food, Drug, and Cosmetic Act of

1938. (This act is best known for requiring premarket notification for the safety of new drugs,

a requirement that was extended to include premarket approval of the efficacy as well as the

safety of new drugs in the Drug Amendments of

1962.) The 1938 act defined medical devices as (21

U.S.C. § 321 (h)):

. . . instruments, apparatus, and contrivances, including their components, parts and accessories,

intended (1) for use in the diagnosis, care, mitigation, treatment, or prevention of disease in man

or other animals; or (2) to affect the structure

or any function of the body of man or other

animals.

The 1938 act authorized FDA to inspect any site

in which devices were manufactured, processed,

packed, or held (21 U.S.C. § 374). It also authorized FDA to seize adulterated or misbranded medical devices; request an injunction against their

production, distribution, or use; or seek criminal

prosecution of the responsible manufacturer or

distributor. But the agency could not take action

until after a device had been marketed.

In the early regulatory actions taken against

adulterated or misbranded devices, FDA was able

to use expert testimony to prove its allegations.

Over time, however, FDA increasingly had to test

devices suspected of violating the law in order to

remove these devices from the market (340).

As medical devices became more complex after

World War II, attention turned to the regulation

of legitimate devices as well. But FDA could still

act only after devices were distributed and also

97
98 . Federal Policies and the Medical Devices Industry

had the burden of proving that a particular item

was misbranded or unsafe, because devices were

not subject to premarket approval (12). In the late

1960s, however, the courts ruled that certain

products (such as nylon sutures and antibioticsensitive discs) that fell in the grey area between

drugs and devices could legally be considered

drugs and subjected to premarket approval requirements for new drugs (12,302); subsequently,

FDA regulated as “new drugs” such products as

some intrauterine devices (IUDs), some contact

lenses, and some in vitro diagnostic products.

Furthermore, during the late 1960s, Congress

addressed public health problems associated with

radiation emissions from electronic products.

Under the Radiation Control for Health and Safety

Act of 1968 (Public Law 90-602), Congress established a radiation control program to authorize the

establishment of standards for electronic products,

including medical and dental radiology equipment.

From the early 1960s to 1975, six Presidential

messages were given and 28 bills were introduced

to enact medical device legislation.

A 1969 Department of Health, Education, and

Welfare review of the scientific literature for injuries associated with medical devices that was

conducted by the Cooper Committee (named after

its chairman, Theodore Cooper, then Director of

the National Heart, Lung, and Blood Institute of

the National Institutes of Health) estimated that

over a 10-year period, 10,000 injuries were associated with medical devices, of which 731 resulted

in death (339).

The vast majority of these problems were associated with three device types: artificial heart

valves, 512 deaths and 300 injuries; cardiac pacemakers, 89 deaths and 186 injuries; and intrauterine

contraceptive devices, 10 deaths and 8,000 injuries

(339). As observers noted, however, there had

been no sensational event or public tragedy to

spur more stringent regulation of medical devices

such as the events leading to the 1962 Drug Amendments (165,328).

Additional examples of hazards associated with

medical devices were documented in congressional

hearings in 1973. These included prosthetic and

orthopedic implants of improper materials, cardiac defibrillator with faulty electrical circuitry,

incubators in which temperatures reached as high

as 1450 F, plastic tracheotomy tubes with obstructions, and faulty valves on emergency oxygen

respirators (339).

The developments just described eventually

culminated in the enactment of the Medical Device Amendments of 1976 (Public Law 94-295).

THE MEDICAL DEVICE AMENDMENTS OF 1976

The situation prior to enactment of the Medical ●

Device Amendments in 1976 was that FDA could

impose premarket approval requirements on only

a limited number of devices that could legally be ●

considered new drugs (see above). FDA did have

the power to inspect the premises where devices

were manufactured and distributed, but had no ●

power to require that owners of these premises

notify FDA that they were in the device business.

to require that businesses involved with medical devices register their establishments and

list their devices annually,

to impose regulatory requirements (standards

or premarket approval) in proportion to the

degree of risk of a device, and

to impose other general controls on all devices to assure safety and effectiveness.

And FDA could attempt to remove mislabeled or FDA continues to have the authority granted by unsafe devices only on a case-by-case basis after

the devices had been marketed. the 1938 act to inspect any establishment in which

devices are manufactured, processed, or packed,

As a result of the 1976 Medical Device Amend- whether or not these establishments are exempt

ments, FDA currently has the authority: from registration.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 9 9

The definition of medical device was changed

in the 1976 amendments to (Public Law 94-295):

. . . an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or

other similar or related article, including any component, part or accessory, which is—

(1) recognized in the official National Formulary,

(2)

(3)

This

or the United States Pharmacopoeia, or any

supplement to them,

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

intended to affect the structure or any function of the body of man or other animals, and

which does not achieve any of its principal

intended purposes through chemical action

within or on the body of manor other animals

and which is not dependent upon being metabolized for the achievement of any of its principal intended purposes.

last clause in the definition (not achieving

its principal purposes through “chemical action

within or on the body” and “not dependent upon

being metabolized”) distinguishes devices from

drugs.

Devices are to be categorized by type, on the

basis of recommendations from FDA classification panels, into three regulatory classes reflecting their potential risk:

● Class I—general controls,

● Class II—performance standards, and

● Class III—premarket approval.

Class I, general controls, encompasses devices

for which general controls authorized by the act

are sufficient to provide reasonable assurances of

safety and effectiveness. Tongue depressors are

an example. Manufacturers of Class I and all other

devices must register their establishments and list

their devices with FDA, notify FDA at least 90

days before they intend to market the device, and

conform to good manufacturing practices. Good

manufacturing practices apply to the manufacturing, packing, storage, and installation of devices.

Class II, performance standards, contains devices for which general controls are considered

insufficient to ensure safety and effectiveness and

information exists to establish performance standards. X-ray devices are an example.

Class III, premarket approval, applies to devices for which general controls are insufficient

to ensure safety and efficacy, information does

not exist to establish a performance standard, and

the device supports life, prevents health impairment, or presents a potentially unreasonable risk

of illness or injury. Cardiac pacemakers are an

example.

Preamendments devices were to be so classified

and placed in Class I, II, or III. Postamendments

devices found to be “substantially equivalent” to

products on the market before 1976 were to be

put into the same class as their preamendments

counterparts and could be marketed immediately,

although those in Class III could eventually be required to demonstrate safety and effectiveness.

Other postamendments devices were to be automatically classified into Class 111, although the

manufacturer could petition FDA for reclassification into Class I or II; thus, these devices could

not be marketed until they had completed FDA

premarket approval for safety and effectiveness,

In implementing the 1976 amendments, preamendments Class 111 devices and their postamendments substantially equivalent counterparts were

to be treated differently from truly new postamendments Class III devices. The 1976 amendments stipulate that manufacturers of preamendments Class III devices cannot be required to

present safety and effectiveness evidence until 30

months after the effective date of a final classification regulation or until 90 days after publication

of a final regulation requiring submission of evidence on safety and effectiveness, whichever

period is longer (21 U.S. C. § 351(f)(2)(B)). In the

interim, preamendments Class 111 devices and their

postamendments substantial equivalents can continue to be marketed, subject only to the same

general controls as applied to Class I devices.

Manufacturers of any of the following devices

are required by section 510(k) of the law to notify

FDA at least 90 days prior to marketing them:

●

●

●

a device that is to be marketed for the first

time,

a device or product line that may be similar

to one already marketed by another manufacturer, or

a version of an existing device in a form sig-
100 ● Federal Policies and the Medical Devices Industry

nificantly changed or sufficiently modified to

affect its safety and effectiveness.

The manufacturer’s 510k premarket notification

must contain enough information so that FDA can

determine whether or not the device is “substantially equivalent” to a device already being marketed. To be found substantially equivalent, a

postamendments device need not be identical to

a preamendments device, but must not differ

markedly in materials, design, or energy source.

The legislative history reflects a congressional

intent that the term “substantially equivalent” be

construed narrowly where necessary to assure

safety and effectiveness, but less narrowly in instances where differences between a postamendments device and a preamendments device did not

relate to safety and effectiveness (340). If FDA

determines that a postamendments device is substantially equivalent to one already in use, the

manufacturer may market the device.

If FDA finds that a device is not substantially

equivalent to one already in use before the 1976

amendments, the device must go through a premarket approval process. In this case, it is automatically classified into Class 111, although the

manufacturer may petition FDA to reclassify it

into Class I or Class II. (Class I devices can be

marketed, subject only to the general controls

summarized earlier. Since FDA has published no

performance standards for Class II devices (see

section on “Performance Standards” below), these

devices have been subject only to general controls. ) For a Class III device that is not substantially equivalent to a pre-1976 device, information must be provided to FDA to document its

safety and effectiveness before the device can be

approved by FDA for marketing.

In order to develop the safety and efficacy information necessary for market approval of a

Class III device, the sponsor of such a device may

apply to FDA for an “investigational device exemption” (IDE). An IDE, the parallel to the investigational new drug (IND) process in drug regulation, permits limited use of an unapproved

device in controlled settings. Upon completion of

clinical investigations under the IDE, the sponsor may submit to FDA a premarketing approval

application (PMAA) presenting the results of the

clinical investigations, an explanation of what the

device consists of and how it works, manufacturing data that show compliance with good manufacturing practices, and other information that

FDA may require.

If FDA approves this PMAA, the device may

be marketed. (The amendments provide an alternative to the IDE/PMAA route to marketing approval for Class III devices, called a “product development protocol, ” but this has never been

used. The major difference between the product

development protocol and the IDE/PMAA process is that in the former, FDA would participate

in deciding how the device is to be tested. Once

the product development protocol is completed,

the testing results would be submitted to FDA for

approval of the device for marketing (388). )

Finally, the situation for certain “transitional

devices” (i.e., devices that were regulated as “new

drugs” before enactment of the 1976 amendments)

is comparable to that for postamendments devices

that are not substantiality equivalent to preamendments devices. Transitional devices are automatically classified into Class 111, which requires

premarket approval, but may be reclassified,

subsequent to petitioning FDA, into Class I or

Class II,

The current process of getting a medical device

to market is summarized in figure 1.

The Medical Device Amendments contain other

provisions worth noting that are applicable to all

medical devices. First, sale, distribution, or use

of a device may be restricted by FDA if there cannot otherwise be reasonable assurances of its

safety and effectiveness. A device maybe banned

if it presents substantial deception or an unreasonable and substantial risk of illness or injury.

Second, manufacturers, importers, and distributors of devices may be required to establish and

maintain additional records, make reports, and

provide information to FDA to assure that their

devices are safe and effective.

Third, devices are subject to the color additive

provisions of the Federal Food, Drug, and Cosmetic Act, but only if the color additive comes

in direct contact with the body for a significant

period of time.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 101

Figure 1.— How To Get to Market With a Medical Device

MARKET

+

general purpose articles

devices used in research and teaching

Yes custom devices

MARKET

SOURCE: U.S. Department of Health and Human Services, Food and Drug Adrninistratkm, Bureau of Medical Devices, Regulatory ~equirements for ~arketing

a Device (Washington, DC: U.S. Government Printing Office, 19S2).
102 • Federal Policies and the Medical Devices Industry

Fourth, because of concern over the impact of

the 1976 amendments on small manufacturers, a

provision of the law stated that an office should

be established to provide technical assistance to

small firms. FDA has therefore organized an Office of Small Manufacturers Assistance to help

small firms with the regulatory requirements.

Finally, any medical device that can be marketed legally in the United States can be exported

legally without further approval by the FDA.

Medical devices that have not been approved for

use in the United States may also be exported

under certain conditions. Prior FDA approval is

needed for export of devices that: 1) are in violation of performance standards, 2) are subject to

premarket approval, 3) are subject to limited use

under an IDE, or 4) are banned in the United

States. These four types of devices can be exported

only if they have the approval of the country to

which the device is to be exported, and if FDA

has determined that exportation of the device is

not contrary to public health and safety (21 U.S.C.

§ 381(d)(2)). &y other type of device that cannot be marketed in the United States may be exported without FDA approval if the device: 1)

meets the specifications of the foreign purchaser,

2) does not conflict with the laws of the country

of the foreign purchaser, 3) is labeled for export,

and 4) is not sold or offered for sale domestically

(21 U.S.C. § 381(d)(l)). Although prior FDA approval is not required, FDA can at any time require the exporter of such a device to show that

the aforementioned requirements are being met.

IMPLEMENTATION OF THE MEDICAL DEVICE LAW

Registration of Firms and

Listing of Devices

Federal regulations require the following businesses involved with medical devices to register

their establishments with FDA and list their devices annually (21 CFR pt. 807.20):

●

●

●

●

●

manufacturers and other specified processors

of devices,

manufacturers of device components or accessories that are ready to be used for and

labeled for a health-related purpose,

initiators or developers of device specifications,

repackagers and relabelers, and

initial distributors of imported devices.

Manufacturers of device components and raw

materials who would not otherwise be required

to register, dispensers of devices, licensed medical practitioners, manufacturers of general-purpose articles, manufacturers of devices solely for

veterinary use, and manufacturers of devices

solely for research and training are exempt from

registration (21 CFR pt. 807.65).

The number of device establishments registered

with FDA in 1980 was 6,073. (This number differs from the number of establishments cited in

ch. 2, mainly because the FDA list includes nonmanufacturing entities such as distributors. ) By

1982, the number had increased to 7,636 registered establishments, 6,585 domestic and 1,051

foreign, listing approximately 41,500 products.

More than 95 percent of the establishments had

fewer than 500 employees, and more than half had

fewer than 50 employees (143). Registration lists

change significantly from year to year. In 1983,

for example, 1,100 firms canceled their medical

device status, while 1,800 firms registered for the

first time with FDA (206).

Two studies by FDA’s Office of Planning and

Evaluation measured “baseline” conditions in order to track changes that may occur in the future.

Some of the studies’ principal findings on device

establishments in 1980 were as follows (392):

●

●

Eighty-two percent of registered domestic

establishments manufactured devices, 20 percent imported devices, and 22 percent repackaged devices (device establishments may

have more than one function).

Sixty-nine percent of domestic establishments were the sole site operated by the

owner/operator, while 28 percent were subsidiaries, branches, or divisions.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 103

●

●

●

●

●

●

Ninety-three percent of domestic owner/

operators (3,948 out of 4,245 in 1980) operated only one medical device establishment.

Forty-two percent of the domestic establishments had 20 or fewer employees, while 29

percent had 100 or more employees.

Larger establishments were more likely than

small establishments to: 1) produce more

types of devices, 2) make an “exclusive” device (a device made by only one or two

establishments), 3) make a Class III device,

or 4) make a “critical” device (defined below

in the section on “Good Manufacturing

Practices”).

Sixty-four percent of listed manufacturers

made devices in only one medical specialty

area (as defined by FDA’s list of classification panels).

Medical device establishments other than

those making diagnostic devices averaged 4.4

products each, while diagnostic device establishments averaged 6.4 products each.

There was little overlap between manufacturers of medical devices and diagnostic devices. Establishments making dental, ophthalmic, and radiological devices were also

highly specialized. Therefore, there appears

to be a segmentation of the industry between

medical and diagnostic devices, and a further

segmentation of the medical devices portion

of the industry between establishments that

are highly specialized and those that make

devices in several areas.

The other study (391) looked at “availability”

of devices, or the number of products for each

device type. A device type may include all products of a particular type (e.g., cardiac pacemakers)

or may include groupings of separate types of

devices that are similar. The more products of a

type, the greater the availability of products of

that type. The analysis in this study was based

on device classifications that were established

enough to use at the time of the analysis, or

devices from about half of the FDA classification

panels established (see “Classification” section

below). Its principal findings on availability were

as follows (391):

● On average, there were nine products per

type, i.e., each device type was made by an

average of nine establishments.

●

●

●

●

●

Product availability was related to class of

device. Class I device types averaged 13.1

products per type; Class II, 7.9 products; and

Class III, 4.5 products.

Devices with only one or two manufacturers

comprised 28 percent of all device types.

Forty-one percent of Class 111, 28 percent of

Class II, and 24 percent of Class I device

types had only one or two manufacturers.

Foreign establishments made 17 percent of

the products examined. Eleven percent of all

exclusive types had only foreign manufacturers; 4 percent were made solely by foreign

manufacturers.

Foreign products accounted for 21 percent of

Class III devices, 19 percent of Class II, and

15 percent of Class I devices.

More than one-third of all obstetrics-gynecology products and nearly two-thirds of

Class I neurological products were of foreign

origin.

Premarket Notification

In addition to listing their devices annually, device establishments must notify FDA through the

510k notification process (see above) when they

intend to market new devices.

Postamendments devices that are not found by

FDA to be “substantially equivalent” to preamendments devices or to postamendments devices that

have been reclassified into Class I or II are presumed to be Class III, and hence to need premarket approval unless the device’s sponsor successfully petitions FDA to reclassify the device

into Class I or II. However, the overwhelming majority of postamendments devices are from manufacturers who are marketing existing device types

for the first time or who have devices that are minor modifications of existing devices. Thus, the

510k premarket notification process, together with

the FDA finding that devices are substantially

equivalent to preamendments devices, has become

the predominant route by which postamendments

devices have reached the market.

An indication of the extent to which postamendments devices have been regulated through the

510)k notification process is reflected in the fact

that, of more than 17,000 notifications received

for fiscal year 1977 through fiscal year 1981, only
104 ● Federal Policies and the Medical Devices Industry

— .

approximately 300 were found to be not substantially equivalent and therefore automatically

placed in Class III. For 65 of these, petitions for

reclassification were received; 28 were approved,

5 denied, 28 withdrawn or converted to other

types of submissions, and 4 were still active at

the end of fiscal year 1981, Of the 28 approvals,

3 were reclassified from Class III to I, and 25 from

Class III to II (143). The number of 510k submissions and the number of submissions found not

substantially equivalent since 1976 are summarized by year in table 32.

The purpose of the 510k notification process

was to keep FDA apprised of what was going on

in the industry. The concept of “substantial equivalence” was included in the law to address the

question of how to treat pre- and postamendments

devices fairly. Two issues were involved: 1) a double standard would exist if a postamendments device had to go through the premarketing approval

process before it could be marketed, while an

identical preamendments device would continue

to be marketed; and 2) a type of monopoly would

in effect be given to a preamendments device if

identical pre- and postamendments devices were

treated differently.

The 510k process, together with a determination of substantial equivalence, has been used extensively for postamendments devices to avoid

Table 32.—Number of “510k” Submissions and

Number Found Not Substantially

Equivalent, 1976-83

Number

Number found not

of “510k” substantially

Year submissions equivalent

1976 (7 months). . . . . .

1977 . . . . . . . . . . . . . . .

1978 . . . . . . . . . . . . . . .

1979 . . . . . . . . . . . . . . .

1980 . . . . . . . . . . . . . . .

1981 . . . . . . . . . . . . . . .

1982 . . . . . . . . . . . . . . .

1983 . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . .

1,362

2,427

2,180

2,714

3,316

3,652

3,780a

N A

b

8

47

43

44

73

63

55

3 2

d

19,431C 365d

aEstimate.

bNA indicates information not available.

cExcluding 1983.

‘As Of July 1983.

SOURCE: U.S. Department of Health and Human Services, Food and Drug Administration, unpublished data, Silver Spring, MD, 1983.

Class III designation and its automatic requirement for premarket approval, or to avoid the involved rulemaking process necessary to reclassify

such devices from Class III to Class I or II.

Use of the substantial equivalence clause to permit the marketing of devices without premarket

approval has been encouraged by FDA’s regulations and practices. First, FDA’s initial proposed

regulations that would have required submission

of a 510k notice if modifications could affect

safety and effectiveness were changed. In the proposed regulations, if FDA determined that modifications could affect safety and effectiveness,

there would be no finding of substantial equivalence, and an evaluation of the difference would

have been made in a PMAA or in a reclassification petition from automatic Class III designation

(53). In the final regulation, however, FDA changed

the wording to “changes that could significantly

affect the safety or effectiveness of the device”

(emphasis added) (21 CFR pt. 807.81(a)(3)(i)).

Second, FDA allows manufacturers to trace

back through a chain of substantially equivalent

postamendments devices to a device on the market before the amendments were enacted. For example, a 1982 device may be approved as substantially equivalent to a 1981 device, which was

approved as equivalent to a 1979 device, and so

on eventually back to a preamendments device.

This practice has been labeled “piggybacking” or,

alternatively, “equivalence creep” (53,331).

Third, the amount of data required to show

substantial equivalence varies widely, depending

on the device. All devices that have been determined not to be substantially equivalent and

which thus must go through premarket approval

are reviewed centrally, but there is no such central review for devices that have been found to

be substantially equivalent (47).

Another issue relating to the 510k notification

process is whether or not notification requirements should be applied to Class I devices. In September 1982, the Scientific Apparatus Makers

Association petitioned FDA to drop 510k notification requirements for Class I device types and to

simplify reporting requirements for Class 11 and

III (82). The petition claimed that Class I devices

would still be subject to the registration require-
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 105

— — —— —... — —

ments and to surveillance under the good manufacturing practices regulations.

Furthermore, notification of intent to market

Class II devices for which no standards exist could

be simplified, and additional information could

be required only for Class III devices and for Class

11 devices that have performance standards. The

petition claimed that these changes would still provide reasonable assurances against new devices

being marketed without a change in classification

or without premarket approval.

FDA subsequently denied the petition, telling

the Scientific Apparatus Makers Association that

the legislative intent was to make decisions on the

basis of generic types of devices, not whether or

not devices were in Class I (80). In addition, FDA

was already exempting some device types from

510k notification requirements. For example, in

its final rule on classifying General Hospital and

Personal Use devices, FDA exempted 30 generic

types of Class I devices from notification requirements. They included medical absorbent fibers

and specimen containers, if the devices are not

labeled or otherwise represented as sterile (306).

Classification of Devices

By the beginning of 1984, FDA had completed

classification of preamendments device types in

only 11 of its 19 medical specialty sections and

had issued proposed classifications for the other

8 sections (see table 33). Final and proposed classifications as of February had placed 460 device

types in Class I, 1,086 in Class II, 138 in Class

III, and, depending on the particular product or

use of the product of a specified device type, 27

in Class I or II, 13 in Class II or III, and one in

Class I, II, or 111 (see table 34).

A “device type” may include all products of a

particular type (see discussion of availability in

the section above, “Registration of Firms and

Listing of Devices”) or may include groupings of

separate types of devices that are similar. Thus,

for example, the device type “obstetrics-gynecology specialized manual instruments” was formed

by merging 18 separate instruments such as umbilical clamps, gynecological surgical forceps, and

uterine sounds (391).

Documentation of safety and effectiveness for

preamendments Class III devices was not immediately required but eventually has to be submitted for marketing to continue. As previously

explained, the 1976 amendments provided a grace

period of 30 months before such requirements

could be imposed, but the grace period does not

begin until final classification is made. Therefore,

for example, the earliest date that FDA could call

for evidence of safety and effectiveness of Class

III devices in the eight medical specialty sections

for which final classifications had not been made

at the beginning of 1984, even if they were finally

classified early in the year, would be in 1986. For

the 11 medical specialties with final classifications,

the grace period had ended for 6 by 1984 (see table

34).

Tables 33 and 34 show the number of Class III

device types for which the 30-month grace period

applies. An indication of the number of device

products that are involved can be gleaned from

the number of postamendments Class III devices

found to be substantially equivalent to preamendments Class III devices. The number of such products is summarized in table 35 by medical specialty

and year of notification. From the table, it can

be seen that, in addition to Class III products on

the market prior to the 1976 amendments, there

were over 1,000 postamendments Class 111 products in use by 1983 through a finding of substantial equivalence. Nearly two-thirds of these products were cardiovascular devices.

On May 5, 1982, the Health Research Group

petitioned FDA to issue regulations requiring device manufacturers to submit PMAAs for preamendments Class III neurological devices (252).

These devices had been classified in final regulations effective October 4, 1979, and the Health

Research Group had petitioned FDA shortly after

the 30-month grace period had ended. FDA’s response was that the 30-month time period established only the earliest date FDA could act (85).

The Health Research Group subsequently wrote

to Rep. John Dingell (D-Mich. ), Chair of the

House Committee on Energy and Commerce and

also Chair of its Subcommittee on Oversight and

Investigations, asking that oversight hearings be

held and that there be consideration of an amend25-406 0 - 84 - 8
106 ● Federal Policies and the Medical Devices Industry

Table 33.-Classification of Preamendments Device Types by Medical Specialty Category, February 1984

Class

I or II or I, II,

Medical specialty category Proposed Final I II Ill II Ill or Ill Total

Neurology. . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . .

Obstetrics-gynecology . . . . . . . . . . . . . . . . .

Hematology . . . . . . . . . . . . . . . . . . . . . . . . .

}

(combined) . . . . . . . . . . . . . .

Pathology

General hospital and personal use.............

Anesthesiology . . . . . . . . . . . . . . . . . . . . . . .

Immunology

)

} (combined) .......................

Microbiology . . . . . . . . . . . . . . . . . . . . . . . .

Physical medicine . . . . . . . . . . . . . . . . . . . . .

Gastroenterology-urology . . . . . . . . . . . . . . .

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . .

Dental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

General and plastic surgery . . . . . . . . . . . . .

Ear, nose, and throat . . . . . . . . . . . . . . . . . . .

Ophthalmology . . . . . . . . . . . . . . . . . . . . . . .

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical chemistry

}

(combined)....................

Clinical toxicology . . . . . . . . . . . . . . . . . . .

Orthopedics . . . . . . . . . . . . . . . . . . . . . . . . . .

Subtotal . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

11128/78

4/9/79

4/3/79

9/11/79

9/11/79

8/24179

11/2/79

4122/80

4122/80

8128/79

1/23/81

12/30/80

1/19182

1122/82

1126/82

1129182

2112/82

2/12/82

712182

9/4/79

2/5/80

2/26180

9/12/80

9/12/80

10/21/80

7/16/82

1119/82

1119182

11123183

11123183

—

—

—

—

—

—

—

—

24

3

5

42

51

21

93

32

9

66

108

48

60

39

105

64

42

32

280

49

23

10

45

7

31

15

564

122

25

47

51

64

175

38

180 522

460 1,086

11 0

24 1

16 0

6 0

2 2

7 0

5 0

2 0

9 4

82 7

13 1

5 0

10 0

4 19

0 0

0 0

24 0

56 2 — —0

138 27

0 0

2 0

0 0

1 0

0 0

1 0

0 0

5 0

2 0

11 0

0 0

1 0

0 0

0 0

1 1

0 0

0 0

2 — 1

13 1

101

138

69

109

94

134

162

81

56

944

185

54

67

119

73

206

77

781

1,725

SOURCE: Federa/ Register publications of specified dates

Table 34.—Classification Status of Preamendments

Device Types, February 1984

Class

I or Il or I II,

Status I II Ill II Ill or lll Total

Final . . . . . . . . 280 56482711 0 94 4

Proposed . . . . . 180 522 56 20 2 1 — — 781

Total . . . . . . . 460 1,086 138 27 13 1 1,725

SOURCE: Seetable33.

ment to the device amendments that would clearly

establish a definite time for submission of data

for preamendments and substantially equivalent

Class III devices (83). The Health Research Group

petitioned FDA again in March 1983, this time

for preamendments Class III obstetrics-gynecology devices and their substantial equivalents,

pointing out that the 30-month grace period had

ended on August 31, 1982 (253).

In September 1983, FDA issued its first ’’Notice

of Intent” to initiate proceedings requiring approval for continued marketing of preamendmerits Class III devices and their postamendments

substantial equivalents in the five medical specialty categories for which the 30-month grace

period had expired. FDA identified the following

devices in these five medical specialty categories

as being the first device types for which safety and

effectiveness evidence would be required (321).

● Hematology and Pathology (combined)

1. Automated differential cell counter

2. Automated heparin analyzer

3. Automated blood cell separator

● Cardiovascular

1. Implantable pacemaker pulse

2. Pacemaker programmer

3. Replacement heart valve

● General hospital and personal use

1. Infant radiant warmer

● Neurology

1. Implanted cerebella stimulator

2. Implanted diaphragmatic/phrenic nerve

stimulator

3. Implanted intracerebral/subcortical stimulator for pain relief
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 107

Table 35.—Number of Postamendments Class Ill Devices Found Substantially Equivalent to

Preamendments Devices by Medical Specialty Category, 1976-83

1976

Medical specialty category (7 mos.) 1977 1978 1979 1980 1981 1982 (as of 7/83) Total

Anesthesiology a

. . . . . . . . . . . . . . . . . . . . . . . . . . . 1 3 5 3 9 3 1 2 27

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . . . . . 33 71 89 121 114 143 94 51 716

Clinical chemistry . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 1 2 0 0 3

Clinical toxicology. . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 0 1 0 0 1

Dental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 6 5 5 4 6 11 3 42

Ear, nose, and throat. . . . . . . . . . . . . . . . . . . . . . . o 3 3 6 5 0 3 0 20

Gastroenterology-urology a . . . . . . . . . . . . . . . . . . 0 4 2 3 8 5 8 10 40

General and plastic surgery . . . . . . . . . . . . . . . . . 6 5 2 6 5 14 2 5 45

General hospital and personal usea . . . . . . . . . . 0 1 0 2 2 2 2 1 10

Hematology a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . o 9 2 8 4 0 3 1 27

lmmunology a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 4 1 3 3 2 1 16

Microbiology a . . . . . . . . . . . . . . . . . . . . . . . . . . . o 5 4 8 12 10 3 1 43

Neurology a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 6 2 3 8 5 2 0 31

Pathology a . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . o 0 0 0 0 0 2 0 2

Obstetrics-gynecology a . . . . . . . . . . . . . . . . . . . . 2 2 3 1 3 2 0 2 15

Ophthalmology . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 3 7 5 3 3 9 6 38

Orthopedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . o 1 0 1 2 2 0 2 8

Physical medicinea . . . . . . . . . . . . . . . . . . . . . . . . o 1 1 1 0 0 0 0 3

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . o 0 0 1 0 1 3 0 5

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

— —— —

52 124 126 175 183 202 145 85 1,092

%Iassification completed (as of the endof19S3) (see table 33).

SOURCE: U.S. Department of Health and Human Sewices, Food and Drug Administration, unpublished data, Silver Spring, MD, 19S3.

● Obstetrics-gynecology

l. Transabdominal amnioscope (fetoscope)

and accessories

2. Contraceptive uterine device (IUD) and introducer

3. Contraceptive tubal occlusion device (TOD)

and introducer

The Federal Register notice also announced that

FDA was proposing a rule to require the filing of

a PMAA for one of these devices, the implanted

cerebellar stimulator. Four months after the announcement, no PMAAs had been submitted,

probably because of difficulty in providing data

that supported the stimulator’s safety and effectiveness (86). If IDEs are obtained, however, the

implanted cerebellar stimulator may continue to

be used for the limited purpose of obtaining safety

and effectiveness data from clinical trials (321).

Reclassification of Devices

As explained earlier, the sponsors of postamendmerits devices that are not substantially equivalent

to preamendments devices and are automatically

put in Class III may petition FDA for reclassification into Class I or II. The major reclassification

issue has not been with these devices, however,

but with one of the transitional devices—contact

lenses,

Under the 1976 Medical Device Amendments,

transitional devices (products that had previously

been regulated as ’’newdrugs”) were automatically

classified in Class III and made subject to premarket approval requirements, although the manufacturers could petition FDA for reclassification.

All contact lenses made of polymers other than

polymethyl-methacrylate (hard lenses) had been

previously declared to be “new drugs” and placed

in Class 111 when the 1976 amendments were

enacted. Subsequently, some manufacturers did

the testing required to meet the premarket approval requirements.

In March 1981, the Contact Lens Manufacturers

Association (CLMA), representing predominantly

small contact lens manufacturers, petitioned FDA

to reclassify from Class 111 to 11 contact lenses consisting principally of rigid plastic materials. CLMA’s

contention was that these lenses were safe and effective enough to be placed in Class II, thus making further testing unnecessary.

FDA subsequently concluded that CLMA’s petition did not meet all of the requirements of the

regulations (21 CFR pt. 860.123). The agency also
108 ● Federal Policies and the Medical Devices Industry

1932 Early 1950s

Mid 1970s

Photo credits: Alan R. Kahn

This picture shows three steps in the evolution of the cardiac pacemaker, from a device carried on the patient’s back,

to an external device with internal leads, to a fully implantable pacemaker Implantable cardiac pacemakers are regulated

as Class Ill devices

determined that the objective of CLMA’s petition In December 1983, FDA withdrew the proposed

was meritorious, however, and in November rule on rigid gas-permeable lenses on the basis of

1982, proposed to reclassify both daily-wear soft the fact that its review found insufficient publicly

contact lenses and daily-wear rigid gas-permeable available, valid scientific evidence to show that

contact lenses from Class III to Class I (rather than the device was safe and effective (323). The into Class II) (313). formation had to be based on “valid scientific
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 109

evidence” (21 CFR pt. 860.7(c)), and that evidence

had to be publicly available because the 1976

amendments prohibit the use of trade secrets, confidential commercial information, or detailed information on safety and effectiveness contained

in the premarket approval application of manufacturers who have succeeded in obtaining approval for their devices.

Following its decision not to down-classify rigid

gas-permeable contact lenses, however, FDA

decided to review its contact lens guidelines for

IDEs and PMAAs to determine under what conditions some parts of the guidelines could be

avoided, thereby simplifying the premarket approval process (207).

Good Manufacturing Practices

Good manufacturing practices regulations,

which apply to the manufacturing, packing, storage, and installation of devices, are one of the important ways in which Class I devices were to be

regulated. They also apply to Class II and III

devices.

The good manufacturing practices regulations

implemented by FDA for device manufacturers

distinguish between“critical” and “noncritical”

devices (21 CFR pt. 820):

“Critical device” means a device that is intended

for surgical implant into the body or to support

or sustain life and whose failure to perform when

properly used in accordance with instructions for

use provided in the labeling can be reasonably expected to result in a significant injury to the user.

“Noncritical device” means any finished device

other than a critical device.

Most critical devices are in Class III, but not all

Class III devices are critical.

The good manufacturing practices regulations

require that the manufacturer keep a device master record containing the device’s specifications,

production processes, and quality assurance procedures; a historical record of the device indicating

control numbers and dates of manufacture and

distribution; and complaint files regarding the device’s performance. For critical devices, the manufacturer must have more detailed monitoring of

production and distribution and must maintain

individual control numbers and device master records. Additional compliance programs are cited

specifically for manufacturers of cardiac pacemakers

and sterile devices (389). FDA has exempted manufacturers of some noncritical devices in Class I

(e.g., specimen containers) from most of the recordkeeping requirements of the good manufacturing

practices regulations.

In a review of reports of good manufacturing

practice inspections conducted primarily on Class

11 and III device manufacturers from January 1979

through December 1981, out of 3,811 good manufacturing practices inspections, 62 regulatory actions were taken. FDA concluded that the compliance rate for larger firms tended to be somewhat

better than for smaller firms, but overall compliance by the industry was good, and there was

a reasonable level of compliance for smaller firms

(143).

Performance Standards

Proposed and final classifications as of early

1984 had placed nearly 1,100 of the more than

1,700 device types in Class 11 (see tables 33 and

34, above). Yet no mandatory performance standards have been issued by FDA for any Class II

device types.

Class 11 has become a de facto catchall regulatory category, intermediate between the minimum

regulatory requirements imposed by Class I general controls and the full premarket approval

process associated with Class 111 devices. Operationally, however, because no performance standards have been issued for Class II device types,

Class II devices have been regulated as though

they were Class I devices.

FDA has approached further regulation of Class

II device types in several ways. First, in 1982, FDA

proposed that the following steps could be considered before promulgation of a mandatory performance standard (387):

●

●

●

●

request that manufacturers voluntarily solve

device problems,

publicize particular device problems,

publish educational and technical information directed at device use,

participate in developing a voluntary

standard,
110 • Federal Policies and the Medical Devices Industry

● make use of other general controls such as

those for adulteration and misbranding, and

● develop guidelines.

Second, in mid-1982, the Administration submitted to Congress a proposal to repeal the present statutory procedures for developing and establishing performance standards for medical devices

by substituting a simpler notice-and-comment

rulemaking procedure under the Administrative

Procedures Act. The device amendments require

a five-step process: 1) initiate by Federal Register

notice a proceeding for a performance standard,

which provides the opportunity for manufacturers

to request a change in classification, denial of requests for reclassification, or initiation of reclassification by Federal Register notice; 2) invite persons by Federal Register notice to submit an existing standard as a proposed performance standard or an offer to develop such a standard; 3) accept or reject such offers or proceed to develop

such standards; 4) publish a notice of proposed

rulemaking; and 5) promulgate a performance

standard (21 CFR pt. 861.20).

The proposal the Administration submitted to

Congress would have eliminated the second and

third steps. Rep. Henry A. Waxman (D-Calif. ),

Chair of the Subcommittee on Health and the

Environment of the House Committee on Energy

and Commerce, agreed to sponsor the bill but

added a section requiring manufacturers to notify

FDA if they learn of device defects that present

unreasonable risks of substantial harm (see subsequent section on “Postmarketing Surveillance” for

a related discussion). H.R. 7052, the Medical Device Amendments of 1982, was introduced by

Rep. Waxman on August 19, 1982, but was not

acted on. Similar legislation, including discretionary authority to apply performance standards,

was reported to be under consideration at the Department of Health and Human Services/FDA at

the beginning of 1984 (87).

Third, in mid-1983, FDA finally identified 11

priority Class II devices, announced its intent to

proceed with development of performance standards, and started the five-step process (see above)

by providing the opportunity to submit a request

for a change in the classification of the first of

these 11 devices, the continuous ventilator (320).

Do the 1976 Medical Device Amendments in

fact require the use of performance standards?

Two sections of the amendments seem in conflict

on this point. Section 514(a)(l) of the act states

that: “The Secretary may by regulation . . . establish a performance standard for a Class II device” (emphasis added). But the act’s definition

of a Class 11 device is: “A device which cannot

be classified as a Class I device because the [Class

I] controls . . . by themselves are insufficient to

provide reasonable assurance of the safety and effectiveness of the device, for which there is sufficient information to establish a performance standard to provide such assurance, and for which it

is therefore necessary to establish for the device

a performance standard . . . to provide reasonable assurance of its safety and effectiveness” (emphasis added) (§ 513(a)(l)(B)).

What if there is insufficient information to

establish a performance standard? That condition

in itself does not require Class III designation. A

device is a Class III device if it “cannot be classified

as a Class II device because insufficient information exists for the establishment of a performance

standard . . . and (it) is purported or represented

to be for a use in supporting or sustaining human

life or for a use which is of substantial importance

in preventing impairment of human health, or

presents a potential unreasonable risk of illness

or injury” (emphasis added) (§ 513(a)(l)(0).

FDA, in classifying a device into Class II, has had

to conclude that sufficient information to develop

performance standards in fact exists (see the definition of Class II, above). Yet the fact that no

mandatory performance standards have been

issued casts doubt on this conclusion.

Moreover, FDA has chosen Class II instead of

Class III designation even in some cases where

a device was of an implantable type. This is illustrated by proposed classifications for General

and Plastic Surgery devices, where seven implantable device types (including artificial chins,

ears, and noses) were proposed for Class II instead of Class 111 designation (311). The Health

Research Group, commenting on these proposed

classifications, stated that implantable devices

should be in Class III (253).
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 111

Investigational Device Exemptions

An IDE permits limited use of an unapproved

Class III medical device in controlled settings for

the purpose of collecting data on safety and effectiveness. This information can subsequently be

used in support of a PMAA.

The regulations that FDA has implemented on

IDEs make a distinction, which is not expressly

stated in the law, between “significant risk” and

“nonsignificant risk” devices. A “significant risk

device” is an investigational device that (21 CFR

pt. 812.3(m)):

(1)

(2)

(3)

(4)

is intended as an implant and presents a potential for serious risk to the health, safety,

or welfare of a subject;

is purported or represented to be for a use in

supporting or sustaining human life and presents

a potential for serious risk to the health,

safety, or welfare of a subject;

is for a use of substantial importance in diagnosing, curing, mitigating, or treating disease,

or otherwise preventing impairment of human

health and presents a potential for serious risk

to the health, safety, or welfare of a subject;

or

otherwise presents a potential for serious risk

to the health, safety, or welfare of a subject.

Sponsors of investigations of significant risk

devices must obtain approval by an institutional

review board, if one exists, and must also apply

for an IDE from FDA. Investigations may not

begin until FDA approval is granted. The determination of whether a device is a significant risk

device is initially made by the sponsor. The institutional review board reviewing the investigational plan also makes this determination and has

the authority to approve, require modifications,

or disapprove the investigational plan. If the review board disagrees with a sponsor’s conclusion

that a device is a nonsignificant risk device, the

sponsor has to notify FDA and apply for an IDE.

If no institutional review board exists or if FDA

finds the institutional review board’s review inadequate, the sponsor may submit an application

for an IDE directly to FDA (21 CFR pt. 812.62).

FDA will then decide whether an IDE is needed.

The sponsor of a nonsignificant risk device need

not apply for an IDE but must obtain approval

to test the device from the institutional review

board of the institution where testing will occur

and must meet certain reporting, recordkeeping,

and monitoring requirements.

The IDE not only allows device sponsors to test

the Class III device before approval is obtained

for marketing, but also is a method of keeping

FDA apprised of the existence of clinical testing.

For nonsignificant risk devices, FDA need not actually be informed of the specifics of testing, and

these devices are considered to have approved applications for IDEs as long as the institutional review board has approved the testing and certain

recordkeeping and other requirements are met (21

CFR pt. 812.2(b)).

(At a December 1983 meeting of the Food and

Drug Law Institute, an FDA official unofficially

raised the idea of a written notification to FDA

of the existence of a nonsignificant risk investigation in addition to the normal nonsignificant risk

IDE procedures. The principal purpose was to inform FDA of the existence of clinical testing to

ensure that a reasonable amount of safety and effectiveness information was gathered in preparation for premarket approval, and to prevent manufacturers from profiting on unapproved devices

(81).)

In a few instances, FDA guidelines have established requirements concerning the numbers of patients required in a clinical study and the length

of time they need to be followed. For example,

in December 1983 FDA advised manufacturers of

YAG (yttrium aluminum garnet) lasers, a Class

111 device which is used in cataract surgery, that

a reasonable study population was 500 patients

studied for 6 months and that the sponsors should

not add to the study without FDA approval (81).

The number of significant risk IDEs that have

been issued from 1977 to 1982 is summarized in

table 36 by medical specialty category. The numbers in that table reflect the changing status of the

IDE regulations. Until 1978, FDA required IDE

applications solely for studies of certain Class III

devices that had been previously regulated as new

drugs (i.e., “transitional devices”). In February

1978, the IDE regulations for intraocular lenses

became effective (21 CFR pt. 813), and IDE ap-
112 ● Federal Policies and the Medical Devices Industry

Table 36.—lnvestigational Device Exemptions (IDEs) for Significant Risk Devices by

Medical Specialty Category, 1977-82

Medical specialty category 1977 1978a

1979 1980b1981 1982

Anesthesiology . . . . . . . . . . . . . . . . . . . . . . . . . .

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical chemistry . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical toxicology ., . . . . . . . . . . . . . . . . . . . . . . .

Dental ............ . . . . . . . . . . . . . . . . . . .

Ear, nose, and throat . . . . . . . . . . . . . . . . . . . . . . .

Gastroenterology-urology . . . . . . . . . . . . . . . . . . .

General and plastic surgery . . . . . . . . . . . . . . . . .

General hospital and personal use . . . . . . . . . . .

Hematology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Immunology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Microbiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Neurology . . . . . . . . . . . . . . . . . . . . . . . . . . . , . . . .

Pathology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Obstetrics-gynecology. . . . . . . . . . . . . . . . . . . . . .

Ophthalmology . . . . . . . . . . . . . . . . . . . . . . . . . . .

Orthopedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Physical medicine . . . . . . . . . . . . . . . . . . . . . . . . .

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

0

0

0

0

0

0

0

4

2

0

0

0

0

0

0

0

o

0

7

0

3

0

0

0

0

0

1

0

0

1

0

0

0

0

48

0

0

0

53

o 0

2 21

2 0

0 0

1 4

0 1

1 10

2 5

0 4

0 0

0 2

0 1

3 2

0 0

0 21

21 24

0 4

1 0

0 6

33 105

8 11

39 32

0 1

0 0

0 2

1 4

28 21

7 12

4 4

0 0

2 0

0 0

4 9

0 0

53 34

34 34

12 11

2 0

9 1

203 176

Total

19

97

3

0

7

6

60

31

14

0

5

1

18

0

108C

162

27

3

16

577

alntraocular lens regulation final in February 1978

blDEregula~onf inal in January 1980.

cAlmost exclusively cervical cap studies.

SOURCE: U.S. Department of Health and Human Services, Food and Drug Adminmtration unpubhshed data, Sflver Spring, MD, 1983

placations for intraocular lenses began to be received. In January 1980, IDE regulations applicable to other types of devices were made final

(21 CFR pt. 812).

The relationship between requests for approval

and FDA’s finding that IDEs were in fact needed

is indicated by the fact that nearly 60 percent of

approximately 400 requests for approval of IDEs

for significant risk devices that FDA received between July 1981 and July 1982 were approved with

or without additional conditions within 30 days.

The remainder were disapproved, subject toadditional justification, withdrawn by the sponsor,

or returned to the sponsor with the finding that

an IDE was not necessary (143).

Premarket Approval

In 1980, FDA developed guidelines for the submission of PMAAs and also published proposed

regulations on premarket approval requirements

(308). However, the regulations had not been

finalized by early 1984. Under the guidelines currently inuse, when a PMAA is approved, the approval letter states that information on adverse

reactions and device defects must be reported

within 10 days. And according to an FDA prescription device regulation (21 CFR pt. 801.109)

predating the 1976 amendments, certain devices

may be sold or distributed only by or on the order of licensed practitioners. FDA has used these

restrictions as a condition of approval for certain

devices.

As indicated earlier, the only types of devices

that have had to go through the full premarket

approval process so far are: 1) postamendments

devices that are not substantially equivalent to

preamendments devices, and 2) ’’transitional devices” that have not been reclassified as Class I

or II and postamendments devices substantially

equivalent to them. Preamendments Class III

devices and their postamendments equivalents will

eventually have to go through a similar approval

process. In September 1983, FDA identified the

first 13 preamendments Class III device types for

which evidence of safety and effectiveness will

soon be required if continued marketing is to be

allowed (see section on “Classification of Devices, ” above) (321).

The number of postamendments Class III devices that have successfully passed through the

full premarket approval process and the number

of transitional devices that have received premarket approval from 1977 to 1982 are summarized in table 37 by medical specialty category.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 113

Table 37.—Approved Premarket Approval Applications (PMAAs) by Medical

Specialty Category, 1977-82

Medical specialty category 1977 1978 1979 1980 1981 1982 Total —

Approved PMAAs:

Anesthesiology . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical chemistry . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical toxicology . . . . . . . . . . . . . . . . . . . . . . . . .

Dental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Ear, nose, and throat . . . . . . . . . . . . . . . . . . . . . . .

Gastroenterology–urology . . . . . . . . . . . . . . . . . . .

General and plastic surgery . . . . . . . . . . . . . . . . .

General hospital and personal use . . . . . . . . . . .

Hematology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Immunology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Microbiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Neurology. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Pathology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Obstetrics-gynecology . . . . . . . . . . . . . . . . . . . . .

Ophthalmology . . . . . . . . . . . . . . . . . . . . . . . . . . .

Orthopedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Physical medicine . . . . . . . . . . . . . . . . . . . . . . . .

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Approved PMAAs for new devices:

Anesthesiology . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical chemistry . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical toxicology . . . . . . . . . . . . . . . . . . . . . . . . .

Dental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Ear, nose, and throat . . . . . . . . . . . . . . . . . . . . . . .

Gastroenterology-urology. . . . . . . . . . . . . . . . . . .

General and plastic surgery . . . . . . . . . . . . . . . . .

General hospital and personal use . . . . . . . . . . .

Hematology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Immunology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Microbiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Neurology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Pathology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Obstetrics-gynecology . . . . . . . . . . . . . . . . . . . . .

Ophthalmology . . . . . . . . . . . . . . . . . . . . . . . . . . .

Orthopedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Physical medicine . . . . . . . . . . . . . . . . . . . . . . . . .

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Approved PMAAs for transitional devices:

Anesthesiology . . . . . . . . . . . . . . . . . . . . . . . . . . .

Cardiovascular . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical chemistry . . . . . . . . . . . . . . . . . . . . . . . . .

Clinical toxicology . . . . . . . . . . . . . . . . . . . . . . . . .

Dental . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Ear, nose, and throat . . . . . . . . . . . . . . . . . . . . . . .

Gastroenterology-urology . . . . . . . . . . . . . . . . . . .

General and plastic surgery . . . . . . . . . . . . . . . . .

General hospital and personal use . . . . . . . . . . .

Hematology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Immunology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Microbiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Neurology ....., . . . . . . . . . . . . . . . . . . . . . . . . . .

Pathology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Obstetrics-gynecology . . . . . . . . . . . . . . . . . . . . .

o

1

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

7

0

1

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

7

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

o

0

0

0

0

0

0

0

0

0

0

0

0

0

0

0

4

0

0

1

0

1

0

0

0

0

5

0

0

0

6

2

0

0

19

o

3

0

0

1

0

1

0

0

0

0

5

0

0

0

0

2

0

0

12

o

1

0

0

0

0

0

0

0

0

0

0

0

0

0

1

2

0

0

0

0

0

4

1

0

3

4

0

0

0

12

1

0

0

28

1

2

0

0

0

0

0

0

1

0

0

4

0

0

0

0

1

0

0

9

o

0

0

0

0

0

0

4

0

0

3

0

0

0

0

3

3

1

0

1

0

0

4

2

0

0

2

1

0

0

22

1

0

0

40

3

2

1

0

0

0

0

2

2

0

0

2

1

0

0

0

0

0

0

13

o

1

0

0

0

o

2

0

0

0

0

0

0

0

4

5

0

0

0

0

2

2

2

0

0

1

2

0

0

20

2

0

0

40

4

5

0

0

0

0

2

1

2

0

0

1

2

0

0

0

1

0

0

18

o

0

0

0

0

0

0

1

0

0

0

0

0

0

0

8

15

1

0

2

0

3

10

5

0

3

12

3

0

0

60

6

0

0

128

8

13

1

0

1

0

3

3

5

0

0

12

3

0

0

0

4

o

53

o

2

0

0

1

0

0

7

0

0

3

0

0

0

0
114 ● Federal Policies and the Medical Devices Industry

Table 37.—continued

Medical specialty category 1977 1978 1979 1980 1981 1982 Total

Ophthalmology . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 6 12 22 20 60

Orthopedics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 2

Physical medicine . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 0 1 1 2

Radiology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 0 000 0

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 0 0 7 19 27 22 75

SOURCE: ~.~. ~:epatment of Health and Human Setvices, Food and Drug Administration, unpublished data, Silver Spring,

Approved transitional devices are heavily skewed

toward ophthalmic products, which are almost

exclusively contact lenses and contact lens cleaning solutions and, beginning in December 1981,

intraocular lenses. Other examples of transitional

devices include cardiovascular grafts, bone cement, absorbable sutures, and specific types of

immunological tests.

“New” postamendments devices are also concentrated in a few medical specialties, but not to

the extent that ophthalmic devices have dominated approved transitional devices. Among these

new devices are cardiac valves, heart pacemakers

and accessories, cardiovascular catheters, lifesupport monitoring systems, implantable infusion

pumps, artificial hips, and antibody tests for infectious agents.

From 1977 through the end of 1982, 128 Class

III products (53 “new” devices and 75 “transitional” devices) had gained premarket approval.

During the same period, 1,007 Class III products

were approved for marketing through the finding that they were substantially equivalent to

preamendments Class 111 device types (compare

tables 35 and 36). As previously noted, evidence

of safety and effectiveness has not yet been required for these postamendments Class III products found substantially equivalent to preamendments devices. Many of these applications for

postamendments Class 111 devices are for modifications of devices which were already commercially available.

Postmarketing Surveillance

There are a number of existing and potential

methods to monitor hazards associated with the

use of devices that have been marketed. FDA

maintains a Device Experience Network (DEN)

that receives voluntary reports on device hazards;

can require repair, refund, or replacement of devices for hazards or defects; and requires that

manufacturers keep records of complaints as part

of the good manufacturing practices regulations.

Two other methods have been mentioned earlier.

A condition of approval for new Class III devices

approved through the full premarket approval

process is that information that manufacturers receive on device defects and adverse reactions has

to be reported to FDA within 10 days. And manufacturers, importers, and distributors of devices

may be required to provide FDA with information to ensure that their devices are safe and effective.

The major issue in postmarketing surveillance

activities has involved the authority that the 1976

amendments gave to FDA to require that information be provided to FDA to ensure that devices

already on the market are safe and effective. In

late 1980, FDA proposed rules for mandatory device experience reporting, under which manufacturers and distributors of medical devices would

be required to submit reports on devices that: 1)

may have caused a death or injury, 2) may have

a deficiency that could cause a death or injury or

that could give inaccurate diagnostic information

that could result in improper treatment, or 3) are

the subject of a remedial action by the manufacturer (307). Any death that might have been

caused by a device would have had to be reported

within 72 hours of the manufacturer’s or distributor’s receipt of that information, with a followup

report submitted within 7 working days. Reports

also would have had to be submitted within 7

working days after receiving information of any

actual or possible device deficiency that could result in a death or injury.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 115

FDA’s rationale for a mandatory device reporting regulation was twofold. Practitioners and

users of medical devices usually do not report device experiences to FDA but instead contact the

manufacturer for information and advice. Reports

would be required even if the manufacturer determined that the death or injury was not due to the

device or that there was no deficiency, because

FDA expected that few devices would be characterized by their manufacturers as having deficiencies, few reports would be submitted, and reporting of confirmed deficiencies would be delayed

if manufacturers first investigated before reporting (307).

A year later, in late 1981, the proposed rule was

held in abeyance because of comments that the

requirements were overly broad and because of

issuance in early 1981 of Executive Order 12291

on “Federal Regulation, ” under which regulatory

actions are to be taken only when the potential

benefits of the action outweigh the potential costs.

FDA also announced that it would inspect complaint files maintained under the good manufacturing practices regulations to determine if they

could be used as an adequate or partial substitute for the proposed rule (309). A pretest, phase

I of the review of good manufacturing practices

complaint files was completed on December 31,

1981, and phase II started on July 14, 1982, involving a review of the complaint files of 418

firms.

In May 1983, FDA issued a reproposal on medical device reporting, under which reports would

be required within 15 days of receiving information that “reasonably suggests, or a person alleges

and the manufacturer or importer is aware of the

allegation” that one of its marketed devices “has

caused or contributed to” a death or serious injury or “has malfunctioned” and, if the malfunction occurs, “is likely to” cause or contribute to

a death or serious injury (318).

Data analysis of the phase 11 review of good

manufacturing practices complaint files had been

completed by early 1984, and the report was expected to be available sometime in 1984. FDA has

concluded that the good manufacturing practices

complaint files would not be an adequate substitute for a mandatory device reporting regulation

for several reasons.

First, inspection of complaint files would not

lead to timely reporting. Good manufacturing

practices inspections are conducted every 2 years,

and FDA did not expect more frequent inspections

in the future. Second, with over 6,000 establishments to inspect, there would be a problem with

deciding which and how many establishments to

inspect. Third, the way in which good manufacturing practices records are kept would lead to

practical difficulties in collecting the information

for adverse experience information. As a consequence, FDA expects to reissue a revised mandatory device reporting proposal in 1984, subject

to clearance by the Office of Management and

Budget and other Federal agencies (257).

FDA, in its proposals for a mandatory device

reporting regulation, has stated that its voluntary

reporting system—the Device Experience Network, or DEN—is not an adequate substitute.

DEN is not a comprehensive reporting program,

and FDA does not have the resources to maintain constant contact with all device users to encourage reporting. Furthermore, device manufacturers are the most knowledgeable about their

products and their associated risks and are in the

best position to report to FDA. But few manufacturers report under the DEN system, and many

of the reports that they make are trade complaints

about a competitor’s product, not reports from

the manufacturers of the devices in question. And

in some cases, device manufacturers report device

problems to FDA only after a product recall or

other remedial action is completed (318).

Reviews of DEN data on Class III devices and

of recalls prompted by a hazard with a high

likelihood of serious injury or death resulted in

the following observations (based on information

provided OTA by FDA for the period from 1976

to mid-1983). From the DEN system: deaths allegedly associated with devices were reported

most frequently for pacemakers and heart valves;

actual injury, reported most frequently with pacemakers, heart valves, IUDs, and to a lesser degree but still relatively frequently, with intraocular

lenses; and potential injury, reported most frequently with resuscitation equipment (usually

associated with power failure or other electrical

malfunction), intra-aortic balloon pumps or catheters, pacemakers, heart valves, and intraocular

lenses.
116 • Federal Policies and the Medical Devices Industry

Recalls prompted by risks of serious injury or

death were most frequent for cardiovascular devices, with pacemakers again comprising the

largest subgroup. Thus, the DEN system and

recalls for high risks mostly involve implantable

devices, often involve electrical problems, and

often involve cardiovascular devices.

The DEN system of voluntary reporting and

product recall information do not provide adequate information on the magnitude and frequency

of device-related problems. Voluntary reporting

also includes allegations of death or injury that

may not be associated with the device in question or may be user-related and not due to device defects. FDA also cautions against using DEN

for trend analysis, because reports are voluntary,

use of the system has changed over time, and the

number of reports therefore may reflect trends in

DEN participation and other factors (48). However, voluntary reporting does provide indications

of the types of devices that have associated risks,

and product recall information identifies devices

with significant actual or potential risks.

Other Provisions of the Law

Restricted Devices

Section 520(e) of the Medical Device Amendments added a provision for “restricted devices”

authorizing FDA to issue regulations imposing

restrictions on the sale, distribution, or use of

devices. FDA was also authorized to regulate

advertising of restricted devices and to inspect

manufacturers’ records related to restricted devices. Prior to the amendments, the sale and distribution of some devices were authorized only

through “prescriptions” by designated persons

(e.g., physicians) (21 CFR pt. 801.109). Immediately following the enactment of the law, FDA

published a notice announcing that FDA considered “restricted devices” to include all “prescription devices” (303).

When FDA attempted to inspect the records for

some prescription devices, however, some manufacturers refused to comply, claiming that FDA

had to first issue regulations designating prescription devices as restricted devices. The U.S. District

Courts involved in resolving this issue ruled for

the manufacturers, and both the First Circuit and

Second Circuit of the U.S. Court of Appeals affirmed the decisions of the lower courts (30,171).

As a consequence, FDA decided to issue a regulation rather than attempt to establish through

further litigation its authority to inspect records

for restricted devices.

The proposed rule on restricted devices was

published in October 1980 (305). However, FDA

withdrew the proposed rule in November 1981,

stating as its reasons: 1) comments that the current prescription device regulation was sufficient,

and 2) the February 17, 1981, Executive Order

12291 on “Federal Regulation” that required Federal agencies to undertake regulatory actions only

when the potential benefits of the action to society

outweigh the potential costs. FDA also stated that

it would use the authority for inspection of records

required by the good manufacturing practices regulations, as well as the dispensing and labeling

requirements of the prescription device regulations, in lieu of a restricted device regulation (309).

Banned Devices

The banned device provision of the law has

been used once. Prosthetic hair fibers intended for

implantation into the human scalp were banned

in June 1983 (319,324).

Color Additives

FDA has not issued regulations on the color additive provisions of the amendments, but the issue

has so far been limited primarily to tinted contact lenses. All contact lenses that are required to

have premarket approval are also subject to the

color additive provisions of the law. FDA initially

approved tinted contact lenses even though the

color additives had not been listed for that use

before the applications were approved (317).

When FDA subsequently concluded that it had

to apply the color additive provision to tinted contact lenses, it decided that the least unfair method

was to complete action on the pending PMAAs

and to enforce the provision with future PMAAs

(323). FDA is also developing proposed changes

in the procedural regulations for color additives

to govern their use in all applicable devices (323).
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 117

Export of Devices

FDA regulations have not had a great effect on

export of medical devices, because most exported

devices are those that are legally marketed in the

United States and require no special FDA approval.

Most devices requiring FDA approval for export are devices that require but have not yet received premarket approval. The requirement that

the importing country approve imports posed

some problems because of the possibility that

there might not be an official who could give approval. For that reason, FDA has accepted, in lieu

of an express approval, a statement from the

foreign government that it has no laws prohibiting

importation of the device in question. From October 1, 1981 through March 31, 1983, 376 medical devices were approved for export, 13 devices

were disapproved, and 1 previous approval was

rescinded (181).

Assistance to Small Manufacturers

Both the prevalence and absolute magnitude of

regulatory costs increase with establishment size,

DISCUSSION AND CONCLUSIONS

The principal provisions of the statute and

FDA’s activities have been cataloged above. The

1976 Medical Device Amendments attempted to

regulate medical devices in proportion to a device’s degree of risk through a number of pre- and

postmarketing controls. The amendments placed

immediate regulatory priority on significantly new

devices while providing a grace period before

substantial evidence of safety and effectiveness

had to be provided for preamendments Class III

devices and their postamendments equivalents.

Section-by-section descriptions and analyses of

the major provisions of the Medical Device Amendments and their implementation by FDA were

provided above to yield an understanding of the

experience so far with the regulation of medical

devices. The analysis also identified specific regulatory actions that have been proposed as alternatives to the current situation. However, idenbut the costs of regulations appear more unfavorable to the small manufacturer when costs are considered in proportion to establishment size (197).

For example, in a limited study of 30 companies

manufacturing only cardiovascular, anesthesiology, or diagnostic products, both initial and recurring costs per employee were higher for small

plants (fewer than 100 employees) than for larger

plants (100 or more employees) (17).

Small manufacturers also are more likely to

need assistance in complying with the regulatory

requirements. FDA’s Office of Small Manufacturers Assistance has received favorable reviews

by manufacturers. In a survey of medical device

manufacturers, over three-quarters had heard of

the office, about half of those who had heard of

it contacted it, and more than three-quarters of

those contacting the office had found it helpful

(197).

tifying specific regulatory areas and analyzing the

current approaches (and limitations) and their

alternatives are not the same as developing strategies (including maintaining the status quo) for

medical device regulation. The relative significance of actions that could be taken in specific

areas of medical device regulation is hard to determine and justify without relating these actions

to more specific strategies than the general rubric

of meeting safety and effectiveness objectives at

minimal regulatory costs.

In the following analysis, the principal issues

that have arisen in implementing the Medical Device Amendments of 1976 are examined. Areas

to be discussed include:

● the scope of medical device regulation,

● regulation of preamendments Class III devices and their postamendments equivalents,
118 ● Federal Policies and the Medical Devices Industry ———.

• regulation of intermediate classes of devices,

● postmarketing controls, and

● impact of the amendments on medical device

firms.

Scope of Medical Device Regulation

FDA has exempted firms from certain requirements of the 1976 Medical Device Amendments;

under FDA’s IDE regulations, for example, a

distinction is made between “significant” and

“nonsignificant” risk devices, and sponsors of investigations of nonsignificant risk devices obtain

an IDE from an institutional review board rather

than from FDA (see section on “Investigational

Device Exemptions, ” above). The law also expressly permits FDA to exempt firms from notifying FDA about their intent to market selected

devices, and FDA has done so for selected types

of Class I devices, subject to minimal recordkeeping requirements.

The Scientific Apparatus Makers Association

had petitioned FDA to drop notification requirements for Class I devices, claiming that Class I

devices would still be subject to the registration

requirements and surveillance under the good

manufacturing practices regulations. FDA subsequently denied the petition on the grounds that

the legislative intent was to make decisions on the

basis of generic types of devices, and not whether

or not devices were in a specific class (see section

on “Premarket Notification, ” above).

Rather than being considered on the basis of

the present statute’s legislative intent, the proposal

for dropping notification requirements for Class

I devices could be reconsidered in a reassessment

of the statute. With over 7,000 device establishments registered with FDA, listing approximately

41,500 products representing over 1,700 device

types, one important question that arises is whether

the scope of present device regulation is too broad.

Not only could regulatory costs be excessive when

information is gathered that is not going to be

used, but other activities undertaken to help

assure safety and effectiveness could be curtailed

because of competition for funds within a limited

FDA budget.

Regulation of Preamendments Class Ill

Devices and Their Postamendments

Equivalents

As of early 1984, classifications had been completed for device types in 11 of the 19 medical specialty categories, and proposed regulations, most

initially issued in 1982, had been issued for those

in the remaining 8 (see table 34). As preamendments Class III devices and their postamendments

equivalents cannot be required to show substantial evidence of their safety and effectiveness until at least 30 months after final classification, it

will be 1986 at the earliest before manufacturers

of devices in the eight medical specialty categories without final classifications can be required

to show that their products are safe and effective.

FDA could have expedited classification of

high-priority device types within each medical

specialty category instead of waiting to classify

all devices within each category. For example, the

classification process for device types that had

been provisionally designated Class 111 could have

been completed first, thereby starting the clock

on the 30-month grace period.

On the other hand, the medical specialty categories for which FDA first issued final classifications (see table 34) include the categories in which

most of the deaths and injuries were found in a

review of the literature by the Cooper Committee before the amendments were enacted—i.e.,

cardiovascular (heart valves, pacemakers) and

obstetrics-gynecology (IUDs). Devices in these

categories continue to be the major causes of death

or serious injury as reported in FDA’s voluntary

DEN reporting system (see section on “Postmarketing Surveillance, ” above). Thus, the medical

specialty categories for which FDA has completed

classification include those categories containing

devices with the highest known risks.

Related to classification of preamendments devices is the regulation of similar postamendments

devices through application of the “substantial

equivalence” clause and the practice of “equivalence creep” or “piggybacking” whereby a postamendments device can be found “substantially

equivalent” to another postamendments device

that had been previously found to be substantially
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 119

— . .

equivalent to an actual preamendments device.

One issue is the safety and effectiveness of postamendments Class III devices that have been permitted to be marketed through the “substantial

equivalence” route, because the preamendments

devices against which they have been compared

have yet to be required to show evidence of their

safety and effectiveness.

After the 30-month grace period for preamendments devices expires, if FDA requires evidence

of safety and effectiveness for their continued marketing, more evidence on safety and effectiveness

will be available on the preamendments devices

with which postamendments devices are compared. Each manufacturer of a Class III device,

whether pre- or postamendments, would have to

submit a PMAA if required, because FDA cannot consider the evidence of safety and effectiveness in one application when reviewing another

device, even one that was previously found substantially equivalent.

As discussed earlier, FDA has initiated proceedings for some preamendments Class III devices for which the grace period has ended and

which FDA has determined have the highest need

for evidence of safety and effectiveness (e.g., the

implanted cerebella stimulator). Criticisms of the

pace at which FDA classified preamendments

devices, which determines when evidence of safety

and effectiveness of preamendments Class III

devices could be required, could have been muted

if the classification process had been speeded up

for preamendments Class III devices in all categories. Final classification of preamendments

devices is no longer a major issue, however, because classifications have already been proposed

for those medical specialties without final classification (see table 34), and final classification

should occur soon.

The remaining issues are: 1) what type of safety

and effectiveness evidence should be required for

preamendments Class 111 devices; and 2) how the

“substantial equivalence” clause should be applied

by FDA. FDA, in announcing its intent to require

safety and effectiveness evidence for those preamendments Class III devices it has identified as

having high priority, indicated that it intended to

ask for data of the type needed for premarket approval of new postamendments Class 111 devices

(321). However, for less controversial preamendments devices, more flexibility in the types of

evidence that have to be provided maybe appropriate. As for the application of the “substantial

equivalence” clause, other interpretations or other

methods of approving postamendments Class III

devices are possible (see “Policy Options” section

below).

As noted above, the regulations that FDA has

issued on IDEs distinguish between “significant

risk” devices, for which sponsors have to receive

express approval from FDA to conduct studies

under an IDE, and all other Class III devices, of

whose testing FDA need not be actually informed

and which are considered to have approved IDEs

subject to certain conditions (see section on “Investigational Device Exemptions, ” above). This

distinction reflected express statutory authority

and a decision by FDA that risks from Class III

devices varied and monitoring of testing should

reflect the degree of risk.

FDA has also indicated that IDEs will be made

available to manufacturers of preamendments

Class III devices so that they can continue to market their devices if they cannot provide reasonable assurance of safety and effectiveness when

FDA requests such information. In its “Notice of

Intent to Initiate Proceedings to Require Premarket

Approval of Preamendments Devices,” FDA has

stated that within 90 days of the issuance of a final

regulation, a PMAA must be filed or commercial

distribution has to cease.

But an alternative for the manufacturer is to

obtain an IDE and continue distribution for the

limited purpose of obtaining safety and effectiveness data from clinical trials. In addition, under

section 515(6) of the amendments, FDA can extend the grace period if it finds that “the continued

availability of the device is necessary for the public health” (321).

The rationale for this use of the IDE is weak.

Manufacturers of preamendments devices have

had years to prepare to substantiate the safety and

effectiveness of their devices, because the law was

passed in 1976, the classification process is still

not over, and there is a 30-month minimum grace

period from the date of final classification.
120 • Federal Policies and the Medical Devices Industry

Regulation of Intermediate Classes

of Devices

For several reasons, Class II designation has

probably received the most attention. First, Class

II represents the important middle ground of the

whole regulatory approach. Second, the majority

of device types have been placed in Class II (more

than 1,000 out of over 1,700; see table 34). And

third, no performance standards have yet been

issued.

Regardless of whether or not the 1976 statute

requires, rather than permits, the use of performance standards, the fact remains that, as a practical matter, there is little possibility that standards can be formulated for the large number of

device types that have been placed in Class II. If

performance standards were meant to be selectively used, the designation of so many device

types as Class 11 and the resulting perception of

the futility of such an exercise have been damaging to FDA’s efforts, no matter what the rationale.

At the least, the present situation points out the

need for an intermediate regulatory class, the inappropriateness of mandatory performance standards as the sole or even principal method of regulation, and the need for other methods of regulating intermediate devices.

There are, of course, many ways of regulating

an intermediate class of devices. The principal

issues here are: 1) whether a change in the statute is needed before FDA can use other than performance standards, and 2) what types of regulatory controls could be used.

Postmarketing Controls

Postmarketing controls on medical devices are

of two types: 1) removal from the market or

restrictions on the sale, distribution, or use of designated devices; and 2) postmarketing surveillance

of the clinical experiences with medical devices.

FDA can remove a device from the market by

requiring repair, refund, or replacement; by banning it; or by revoking any approval to market

the device. There are two types of restrictions on

the sale, distribution, or use of a device. The first

is a restriction to prescription sale or use, applied

when adequate labeling for lay use cannot be written or when special skills or training are required,

such as diagnosing a disease or condition or prescribing for treatment. The second is a restriction

based on other conditions FDA may prescribe in

regulations in order to provide reasonable assurance of the safety and effectiveness of the device.

The restricted device regulations were withdrawn by FDA with the explanation that the

prescription device regulations were adequate. In

addition, Executive Order 12291 requires that Federal agencies undertake regulatory actions only

when the potential benefits outweigh potential

costs. However, in the original proposed regulation, FDA had stated that (305):

. . . the current determination that a device is a

“prescription” device is quite subjective. Often,

the determination is made by the manufacturer.

FDA therefore proposed the restricted device rule

to make these criteria more objective.

FDA also stated in its withdrawal of the proposed restricted device rule that it would use its

inspection authority under the good manufacturing practices regulations to inspect manufacturers’

records on these types of devices for information

on such matters as deaths and injuries (309). But

the Subcommittee on Oversight and Investigations of the House Energy and Commerce Committee observed that (338):

. . . most of the general controls . . . are geared

toward ensuring that finished devices, when ready

for use, will be free from defects, safe and effective. Restriction, on the other hand, can address

problems with a device once it is in use. It deals

with the risks that practitioners, technicians, or

others who employ the device are doing so improperly due to inadequate training, experience,

facilities, or instructions.

These issues—use of existing sources of information on deaths and injuries, and problems arising from improper use of medical devices rather

than from improper manufacture—have also been

involved in the debates on the types of postmarketing monitoring activities that should be conducted.

One of the expressed reasons why mandatory

device reporting regulations have been held in

abeyance was to examine whether the complaint
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 121

— — —. — —

files which are required under the good manufacturing practices regulations could partially or

completely substitute for the mandatory device

reporting regulations. As described earlier, the examination had been completed by early 1984, with

the conclusion that the good manufacturing practices complaint files are not adequate substitutes

for mandatory reporting (257).

On the question of improper use, the General

Accounting Office has recommended that FDA’s

voluntary DEN reporting system be revised so

that information is included on the scope and

nature of device problems caused by user error

and inadequate maintenance; that the data be

analyzed to identify special problems, areas where

problems might be concentrated, and trends; and

that the results be used to aid in developing solutions. FDA responded that these recommendations would be taken into consideration and that

possible actions would include implementing

educational programs or restricted use criteria

(331).

Thus, FDA may eventually issue restricted device regulations, subject to the current administration’s position on deemphasizing regulatory approaches and its preference for voluntary initiatives.

Furthermore, efforts may be made to upgrade

the voluntary DEN system and disseminate that

information to educate users about potential

hazards.

Impact of the Amendments on

Medical Devices Firms

The preceding analyses examined individual

provisions of the 1976 Medical Device Amendments and their implementation by FDA. A broader

issue is the impact of the amendments on the medical devices industry. Information available on the

impact of the law reflects regulatory implementation by FDA and understanding of the law by

device firms in the first few years following passage of the statute. In evaluating this impact, it

is important to keep in mind that some sections

of the amendments have been implemented fully,

some partially, and some have yet to be addressed.

Two studies that FDA conducted to establish

“baseline conditions” in order to track changes

that occur in the future were summarized earlier,

based primarily on 1977 data (391,392). These

studies showed that the “medical devices industry” is quite heterogeneous. There is a clear separation of the industry into medical device versus

diagnostic testing firms, with little overlap between manufacturers of either type of product.

The medical device portion of the industry is

further separable into establishments that are

highly specialized and those that manufacture

devices in several areas. Sixty-four percent of

manufacturers made devices in only one device

area. Highly specialized areas include dental, ophthalmic, and radiological devices.

Each device type is made by an average of nine

different manufacturers, but this measure of “product availability” or “concentration” in the industry is related to the class of the device. Class I device types averaged 13.1 manufacturers per type;

Class II,. 7.9 manufacturers; and Class III, 4.5

manufacturers. Devices made by only one or two

manufacturers (“exclusive” devices) comprised 28

percent of all device types and followed a similar

pattern. Only one or two establishments were

manufacturing 41 percent of the Class III device

types, compared to 28 percent of Class II device

types and 24 percent of Class I device types.

Large establishments were more likely to make:

1) more device types, 2) an “exclusive” device, 3)

a Class III device, or 4) a “critical” device (defined

by FDA as requiring more rigorous controls in

the manufacturing process).

These findings lead to the following observations. First, the distinction between firms that

manufacture diagnostic tests and firms that manufacture other medical devices probably reflects

the “catchall” nature of the 1976 Medical Device

Amendments, which essentially authorized Federal regulation over all medical products that are

not drugs or biologics. One question is the appropriateness of regulating such distinctly different

products in a similar manner. For example, Class

III medical devices are generally those that are implanted or have life-support or life-sustaining

functions, and criticisms of FDA’s application of

the law to devices of this nature have been raised

when FDA has chosen not to place some of these

types of devices in Class 111 (253).

25-406 0 - 84 - 9
122 ● Federal Policies and the Medical Devices Industry

On the other hand, diagnostic tests pose few

direct risks, but some have been placed in Class

III because defective tests could lead to erroneous

treatment (or no treatment), which in turn could

result in harm to patients. The underlying questions are whether the law’s scope and application

are appropriate, and if not, whether regulation

of diagnostic tests and other medical devices can

be addressed differentially under the present law

or whether new legislative remedies should be explored.

Second, it should be remembered that the findings that devices in higher regulatory classes have

fewer manufacturers per device type and that

larger manufacturers are more likely to manufacture devices in a higher regulatory class represent

the situation that was already present before the

amendments were implemented. Classification

under the 1976 amendments did not cause but

might be expected to reinforce this situation, especially for Class III devices, because of the higher

costs associated with approval.

FDA also commissioned a survey conducted in

the fall of 1981 of medical device manufacturing

establishments that had been registered with FDA

in September 1980 (197). The surveyors concluded

that there was no evidence that the amendments

raised barriers to market entry, reduced innovation, or adversely affected investment, sales, or

employment. For example, one of the survey’s

conclusions, based on information provided by

the surveyed manufacturers, was that there was

no evidence that patent activity had measurably

declined since the Medical Device Amendments

were enacted in 1976.

Figures 2 and 3 provide a more comprehensive

picture of medical device patent activities, summarizing patent applications with the U.S. Patent Office between 1968 and 1979. Patent applications on “low-technology” devices such as bandages,

receptacles, eyeglass frames and lenses began leveling off just prior to the 1976 amendments. But

applications for “high-technology” devices such

as implants, dialysis machines, respiratory devices, and cardiovascular devices continued to increase throughout the decade (see app. D)

The 1981 survey commissioned by FDA found

that a third of all manufacturers had entered the

medical device field after the 1976 statute (197).

Most manufacturers reported increases in domestic and foreign sales, research and development

(R&D) activities, and the number of new devices

introduced since the amendments. Fifty-one percent were more profitable and only 27 percent less

profitable than they had been prior to passage of

the amendments, and 80 percent were optimistic

about doing business in medical devices during

the next decade.

The survey also found that significant R&D

activities were common traits in medical device

firms—whether they were large, medium, or

small—and that the introduction of significantly

new medical devices had been just as common for

small firms as for large firms (197). But when the

survey was conducted in the fall of 1981, only a

quarter of small establishments (1 to 9 employees)—as compared to 63 percent of establishments

with over 500 employees—reported that they

would consider developing and marketing a Class

III device. The surveyors concluded that Class III

designation appears to be more likely to discourage small establishments than large establishments

from developing new devices, but observed that

opinions do not necessarily translate into behavioral differences. They pointed out that 8.4 percent of establishments were manufacturing Class

III devices and that a higher percentage of manufacturers would continue developing Class III

devices.

Somewhat in contrast with the overall optimistic picture of the industry just presented were

manufacturers’ answers to the survey question of

the impact of the Medical Device Amendments

(197). Nearly half (46 percent) stated that Federal

regulation had been a major problem for them,

and 21 percent stated that regulation was the

single most serious problem. However, although

most manufacturers wanted changes in the regulations, they did not believe (53 percent) that device regulation should be abolished, and the vast

majority (80 percent) believed that at least implants and life-support or life-sustaining devices

should be strictly regulated.

The specific problems associated with regulation under the 1976 amendments were varied

(197). One problem reported by a substantial
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 123

Figure 2.–U.S. Patent Applications for Low-Technology Medical Devices, 1968-79

69 1970 172 1973 1974

Year of application

1976

I

1977 1979

SOURCE: U.S. Department of Health and Human Services, Food and Drug Office of Economic Analysis, 

MD, compilation of unpublished data from the U.S. Patent and Trademark Office, December 1983.
124 ● Federal Policies and the Medical Devices Industry

Figure 3.–U.S. Patent Applications for High-Technology Medical Devices, 1968-79

U.S. origin

Foreign origin

1968 1969 1970 1971 1972 1973 1974

Year of application

1978 1979

SOURCE: U.S. Department of Health and Human Services, Food and Administration, Office of Economic Analysis, 

MD, compilation of data from the U.S. Patent and Trademark Office, December 1983.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 125

number of manufacturers in the 1981 survey was

the cost of compliance. In order to meet the regulatory requirements, 64 percent either added new

employees, purchased new equipment, or increased

outside purchases. Absolute costs increased with

establishment size, but when adjusted for establishment size, smaller manufacturers had relatively higher costs per employee in meeting the

regulatory requirements.

Another problem reported by a significant

number of manufacturers was in understanding

what to expect from FDA in meeting the regulatory requirements. Of particular interest is the correlation between manufacturers’ attitudes toward

FDA and their understanding of the regulations.

Of those manufacturers who said they fully understood the regulations, about half (51 percent)

gave FDA a positive rating, and 71 percent stated

that the regulations were effectively protecting the

public. The Office of Small Manufacturers Assistance was one FDA information source that was

positively received by the industry, but difficulty

in understanding the regulatory requirements was

still a major problem and fell disproportionately

on small manufacturers. Thus, a particular priority for regulatory reform was in special efforts

to improve manufacturers’ understanding of the

device regulations.

Despite the negative opinions by manufacturers

regarding regulation, majorities still reported that

registration, product listing, product classification, labeling requirements, premarket approval,

and IDEs had no effects on their establishments

(197). Seventeen percent of manufacturers even

reported that good manufacturing practices have

been of help to them.

Under the 1976 amendments, difficult and complex precedent-setting decisions have been made

on a diversified industry that was not previously

subject to a great deal of FDA regulation. In general, the 1976 Medical Device Amendments have

not had a significant negative impact on the manufacturers of medical devices. Particular segments

of the industry may be more affected than others,

however, and compliance costs affect small manufacturers relatively more than they do large manufacturers.

In the contact lens industry, the issues of the

costs of complying with regulations and small

manufacturers’ entry into the market have converged (see discussion under “Reclassification of

Devices” section, above). Class III designation of

new types of contact lenses (soft lenses, gaspermeable lenses) has made it difficult for many

small companies to gain early entry because of

the costs of gathering clinical evidence on safety

and effectiveness. But there has not been a unified

front by the contact lens industry against Class

111 designation. Rather, large firms that already

have market approval have tended to resist reclassification from Class III to Class I or II. At issue

in this instance is competition between first entrants into the market and subsequent manufacturers. The public policy goals that are at odds

are rewarding companies that first succeed in getting innovations on the market versus achieving

greater availability of products of a particular

type, with price competition as one result.

Throughout the medical devices industry, one

of the impacts of medical device regulation has

been uncertainty over the regulatory requirements. This situation, in retrospect, is understandable, given the fact that the implementation

Photo credit: Bausch & Lomb SOFLENS, Professional Products Division

The new generation of contact lenses, such as the soft contact lens show on the left, are subject to the full premarket

approval process of the Food and Drug Administration. The

older types of hard contact lenses, such as that shown on

the right, no longer have to go through the full premarket approval process.
126 ● Federal Policies and the Medical Devices Industry

—.-—- —

of some provisions of the law has not been initiated or completed and the fact that the majority

of devices have been placed in Class II, despite

inability to proceed with the statutory intent of

regulating this class of devices through performance standards.

Conclusions

During the 8 years since the Medical Device

Amendments of 1976 were enacted, the medical

devices industry has continued to grow, and while

regulatory costs have been incurred, regulation

has generally not had a significant negative impact on the industry. A large part of the industry’s development may be due in part to FDA’s

implementing the 1976 law in ways that would

make market entry easier—as in use of the 510k

premarket notification and a finding of “substantial equivalence” as the predominant route for

devices to be released for marketing—and in part

to FDA’s not implementing or implementing slowly

some of the law’s provisions. The situation for

industry may change if FDA implements all of the

provisions of the amendments, or as new medical devices are developed that make it harder over

time to use the “substantial equivalence” route to

market devices.

Several provisions of the amendments that are

targeted at specific risk categories—such as those

pertaining to the safety and effectiveness of preamendments devices, regulation of Class II devices, and monitoring of devices once they are on

the market—have yet to be fully implemented or

addressed. Yet there is little information that actual risks are systematically occurring or not being addressed by FDA’s choice of priorities in implementing the amendments.

This paucity of information on actual risks can

be interpreted in two ways, based on opposing

POLICY OPTIONS

Most of the attention that has been focused on

medical device regulation since the enactment of

the 1976 Medical-Device Amendments has been

oriented toward questions such as whether a parassumptions. First, it might be taken as an indication that hazards are in fact low, that the current

application of the amendments is satisfactory, and

that it is not necessary to implement all of the

law’s provisions. An alternative interpretation is

that the paucity of information on risks is a deficiency in itself—one that the amendments attempted

to address—and that a lack of information on

risks is a problem that needs to be addressed.

The Medical Device Amendments provided

more effective methods for dealing with fraudulent devices, and the increasingly complex nature

of “high-technology” medical devices was one of

the imperatives for developing premarket screening and testing requirements. Public policy in

these two instances was not primarily dependent

on quantifying the number of injuries currently

caused by medical devices. In the case of fraudulent devices, the amendments provided more effective tools for removing these devices from the

market. For “high-technology” devices, the

amendments attempted to anticipate and minimize

potential risks associated with their use through

pre- and postmarketing controls. Realistically,

however, it might be expected that debates over

how and to what extent medical devices should

continue to be regulated will focus on the costs

to industry versus (lack of knowledge of) the extent of risks associated with medical devices.

In sum, 8 years after the Medical Device Amendments of 1976 were enacted, the medical device

industry has incurred regulatory costs but continues to prosper in general; major sections of the

law remain partially or not implemented, and

there do not seem to be any obvious, major risks

that are not being addressed, a situation that may

reflect either a lack of significant risks or lack of

knowledge of significant risks that do exist.

ticular provision of the 1976 law has been implemented, whether its implementation has been

compatible with congressional intent, and whether

the provision worked in practice as it did in con-
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 127

cept (331,338). A range of options proposed for

specific issues that the current law was designed

to address is provided below. Areas of the law

to be specifically addressed include:

• evaluating the safety and effectiveness of

preamendments devices and their postamendments equivalents,

● developing performance standards for Class

II devices,

. reviewing postmarketing activities and controls, and

. assisting small manufacturers of devices.

Beyond developing options on specific provisions of the law, however, there is the question

of how specific actions fit within an overall regulatory framework. Various overall regulatory

approaches are presented in the first three options

below.

Scope of Medical Device Regulation

Option 1: Continue the basic framework and intent of the 1976 Medical Device Amendments

and make adjustments in implementation or

wording of the specific provisions of the law.

A judgment could be made that the basic framework and intent of the 1976 amendments remains

appropriate and that the law’s implementation by

FDA should proceed, subject to modifications in

the wording or implementation of specific provisions of the law that reflect judgments on the

appropriate balance between methods of ensuring safety and effectiveness and the costs associated with these methods.

FDA, in implementing the 1976 law, has had

to develop a set of priorities so that its limited

resources could be efficiently applied. Congress

could provide more direction to FDA on what it

considers priority issues and what orientation it

considers appropriate within a particular regulatory area. Setting such priorities would entail

weighing benefits to consumers from reducing

risks and ensuring efficacy versus costs to the industry from regulatory requirements. Examples

of priority areas might include approval of new

devices, particularly Class III; safety and effectiveness of preamendments Class III devices; selective monitoring and controls over marketed devices; and development of better information on

device-associated risks.

Congress could also provide direction within

each priority area on the extent of its concern

about ensuring safety and effectiveness versus

minimizing barriers to market entry. Approaches

to balancing safety and effectiveness versus ease

of marketing are reflected by the variation in the

types of safety and effectiveness evidence that

could be required for preamendments Class III

devices and in whether FDA or device manufacturers should bear the burden of proof (see Options 4, 5, and 6).

A different strategy from focusing on which

provisions of the law should be emphasized would

be for Congress to determine which aspects of the

current law do not have high priority. The exemption of devices from some of the law’s requirements through the use of FDA’s discretionary

authority has been previously discussed. FDA has

exempted manufacturers of some Class I device

types (e. g., specimen containers) from having to

notify FDA when they intend to market their

devices and from most of the recordkeeping requirements of the good manufacturing practices

regulations. In the regulations on IDEs, FDA

makes a distinction between “significant risk” and

“nonsignificant risk” Class 111 devices and requires

different procedures for the two. Also mentioned

earlier was a petition to FDA from the Scientific

Apparatus Makers Association, subsequently

denied by FDA as being against legislative intent,

to drop 510k notification requirements for all

Class I devices.

Option 2: Revise the 1976 Medical Device Amendments to reflect the status quo with regard to

FDA’s implementation of the law.

Although the issuance of mandatory performance standards for Class II devices has proved not

to be feasible and FDA has yet to complete the

implementation of several other provisions of the

1976 law, obvious, systematic deficiencies in the

safety and effectiveness of medical devices have

not been apparent. One approach, therefore,

might be to recognize the two-tiered regulatory

approach that has been applied to medical devices

rather than the three-tiered approach originally

built into the law.
128 ● Federal Policies and the Medical Devices Industry

More flexibility could be obtained through the

kinds of controls identified previously to augment

or replace Class II performance standards (see Option 13), but the bedrock of the law could be

limited to: 1) general controls for all devices, and

2) premarket approval requirements for a limited

number of devices, such as implantable or lifesupporting devices. Other current provisions

could also be modified or deleted. For example,

review of preamendments devices could be limited

to high-priority device types, the approach that

FDA is currently taking.

Option 3: Revise the 1976 Medical Device Amendments to exclude certain device types from regulation.

In the previous option, revisions in the law

would be guided by FDA’s implementation of the

law to date. In addition to or in place of that option, Congress might choose to consider statutory

exclusions of some device types.

Statutory modifications could be guided by

focusing on risks, such as the proposal to exempt

Class I devices from notification and recordkeeping requirements, or by focusing on the variety

of medical products currently under the jurisdiction of the amendments, such as the question of

whether it is appropriate to regulate diagnostic

tests in the same manner as other types of medical devices.

Regulation of Preamendments Devices

and Their Postamendments Equivalents

The 1976 amendments provided a 30-month

grace period after final classification before evidence of the safety and effectiveness of preamendments Class III devices would be required by FDA.

For these devices, two issues that remain are what

type of evidence has to be presented and when

that evidence has to be provided to FDA. In part,

these issues are important because of the widespread use of the “substantial equivalence” method

of gaining market entry for postamendments

devices. As previously discussed, a finding of

substantial equivalence will be made if a new device does not differ markedly as to materials,

design, or energy source, and if there is no significant difference with regard to safety and effectiveness. As yet, however, there is no requirement to provide safety and effectiveness evidence

on the preamendments devices with which new

devices claimed to be their substantial equivalents

are compared.

In addition, FDA’s Office of General Counsel

does not consider a finding of “substantial equivalence” an approval. A device is considered approved once a determination is made that it is safe

and effective. The 510k method of obtaining

FDA’s permission to market a device is basically

a determination that the device is substantially

equivalent to a preamendments device, and FDA

has no choice but to allow it to be marketed; it

IS not a determination that the device is safe and

effective (464).

ISSUE:

What evidence of safety and effectiveness

should be required of preamendments

Class III devices?

Option 4: Continue FDA’s current approach of

emphasizing safety and effectiveness evidence

for high-priority preamendments Class III

devices.

Under FDA’s current policy as represented by

this option, preamendments Class III device types

with questionable safety and effectiveness or with

relatively high risks will be addressed by FDA

first, using expert opinion and publicly available

literature. This approach can be viewed as a reasonable allocation of FDA’s limited resources, although FDA has to gather and review information to set areas of priority, and developing the

information can be very resource-intensive for

FDA

Option 5: Limit through legislation requirements

for evidence of safety and effectiveness of preamendments Class III devices to device types

that have specific problems associated with

them.

This option would codify FDA’s current approach so that FDA would have to identify preamendments Class III device types with problems

before it could require evidence of safety and effectiveness. Other preamendments device types
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration • 129 — — . . —

would be presumed to be safe and effective, subject to development of new information. As in the

previous option, this approach could be resourceintensive for FDA because the agency would have

to gather evidence to identify problem devices.

Legislating this approach instead of relying on

FDA’s discretion would reduce uncertainty and

make it explicit that all preamendments Class III

devices will not eventually have to show evidence

of safety and effectiveness.

Option 6: Encourage FDA to accept evidence of

safety and effectiveness such as reviews of the

literature and expert opinion, in lieu of clinical evidence, for preamendments Class III devices.

In the two previous options, the safety and effectiveness of preamendments Class III devices

would in effect be presumed, and FDA would develop information to counter that presumption

before initiating actions. In this option, the burden of providing FDA with evidence of safety and

effectiveness would continue as now to rest with

the manufacturers, but the range of acceptable

types of evidence would be greater. This approach

would enable FDA to screen all device types or

a greater number than would the two previous

options, and the screening process might then be

used by FDA to target problem devices.

A variation of this option would be for FDA

to start with the presumption that clinical data

on devices are required but allow manufacturers

to overcome that presumption with evidence

gained from general use of these types of devices.

ISSUE:

When should safety and effectiveness

evidence be required of preamendments

Class 111 devices?

Option 7: Continue FDA’s interpretation that the

end of the 30-month grace period after final

classification establishes the earliest date that

FDA can require safety and effectiveness evidence on preamendments Class III devices.

Because the 30-month grace period establishes

the earliest date on which the agency can act, FDA

has begun the process of requiring safety and effectiveness evidence for only a few “high-priority”

preamendments Class 111 devices. FDA’s prioritybased review is dictated by the limited resources

available to FDA and the resulting difficulty in

calling for evidence of safety and effectiveness for

all preamendments Class 111 devices as their grace

periods expire. Thus, the issue of when such

evidence will be required is related to the question of what kinds of evidence will be acceptable

(see Options 4, 5, and 6).

Option 8: Establish the end of the 3&month grace

period after final classification as the time when

FDA has to call for safety and effectiveness

evidence on preamendments Class III devices.

This option could be legislated, but its desirability depends on whether FDA takes other approaches to ensuring safety and effectiveness as

discussed above and on the resources FDA could

devote to preamendments devices relative to other

provisions of the law. For example, if FDA takes

the approach in Option 6 of accepting a greater

range of evidence to screen for problem devices,

this option would be much more reasonable to

implement than under current conditions, in

which FDA has assumed responsibility for identifying problem areas.

Option 9: Prohibit use of the IDE to extend the

grace period for preamendments Class III devices that have been required to show evidence

of safety and effectiveness, except when no

acceptable alternatives are available.

The grace period for many preamendments

devices had not ended or had not even begun as

of early 1984, 8 years after the amendments were

passed. Given this extended period of “notification, ” there seems little justification for making

IDE routinely available to preamendments device

manufacturers. Possibly, however, IDEs could be

made available on a case-by-case basis. Routine

use of the IDE to continue limited distribution of

preamendments devices would be less of an issue

if other types of evidence of safety and effectiveness, such as literature reviews and expert opinions, were accepted.

Except for those options specifically calling for

legislation, all of the options pertaining to preamendments Class 111 devices could be implemented under the existing statute. However, Congress could mandate a particular approach through

legislative changes.
130 • Federal Policies and the Medical Devices industry

. — —..——

ISSUE:

Does the “substantial equivalence”

method of entering the market for

postamendments medical devices need

to be revised?

The 1976 Medical Device Amendments require

that any postamendments device not found “substantially equivalent” to a preamendments device

be automatically classified in Class III, with subsequent opportunity to petition for reclassification

of the device in Class I or II. The “substantial

equivalence” clause of the 1976 law was meant

to make a regulatory distinction between those

postamendments devices that are modifications

of commercially available devices from those that

are truly new devices.

Because of the costs and delays in approval

associated with the reclassification process, however, manufacturers of postamendments devices

have had incentives to seek a finding of “substantial equivalence” rather than reclassification so

that they can market their devices much sooner.

Much less information is needed to successfully

claim that a postamendments device is substantially equivalent to a preamendments device than

to gain approval through the premarket approval

process. In fact, the lack of information on the

safety and effectiveness of preamendments devices

raises questions about how determinations of

substantial equivalence can be made.

Option 10: Retain existing procedures for determining ‘substantial equivalence. ”

As previously explained, FDA has begun to call

for safety and effectiveness evidence on highpriority preamendments Class III devices, and

once that evidence is presented and evaluated,

there should be a substantive basis for comparing these devices with postamendments devices

determined to be substantially equivalent. But

the process will take years and may be selective

rather than including all preamendments Class III

devices.

On the other hand, the “substantial equivalence” clause has been a convenient method for

device manufacturers to get their products onto

the market quickly But as new generations of

postamendments devices diverge more and more

from their preamendments antecedents, it will be

harder for manufacturers to use the substantial

equivalence method of market entry. It will also

be harder to practice “piggybacking,” in which

a postamendments device is compared to another

postamendments device and, through a chain of

other postamendments devices, eventually compared to a preamendments device.

More immediately, FDA’s Office of General

Counsel has stated that such “piggybacking” is not

authorized by the amendments (464), and if the

practice of piggybacking ceases, more postamendments devices will eventually be placed in Class

III, and their manufacturers will have to go through

the full premarket approval process or petition

FDA for reclassification.

Option 11: Eliminate automatic classification into

Class III of postamendments devices that are

not found substantially equivalent to preamendments devices, and allow FDA to place a device in the appropriate class at the time of

notification.

Automatic classification into Class 111 of postamendments devices that are not found substantially equivalent to preamendments devices serves

as a second screen in the regulation of post-1976

devices. The first screen is a determination of

whether or not a device is “substantially equivalent” to a preamendments device. The second

screen, with automatic classification into Class 111,

is a presumption that any device that is not substantially equivalent needs full premarket approval, unless the manufacturer successfully petitions FDA for reclassification in Class I or Class

11 Under this option, the burden of responsibility

of coming forth with evidence that rebuts initial

Class 111 designation could remain with device

manufacturers, but manufacturers could be allowed to present this evidence for classification

at the time of notification. This change should reduce current incentives to claim “substantial

equivalence. ”

Option 12: Develop approaches for reviewing new

devices that are different from those for reviewing modifications of commercially available .

devices.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 131

——

Eliminating automatic Class 111 designation of

postamendments devices that are not found substantially equivalent to preamendments devices

might serve to bring out the distinction between

modified and new devices that the “substantial

equivalence” clause was originally meant to provide. GAO has recommended another approach,

eliminating the “substantial equivalence” clause

so that all Class 111 (but not Class I or II) postamendments devices have to go through premarket approval. (Automatic Class III designation for

non-substantially equivalent postamendments devices could also be eliminated so that new devices

that would more appropriately be put into Class

I or II would not have to go through the superfluous step of reclassification. ) In general, then,

the difference in approach could be between preand postamendments devices as originally intended, or between Class III pre- and postamendments devices, where the difference in regulatory

requirements is most pronounced.

Regulation of Class II, or Intermediate,

Devices

More than 1,000 of the 1,700 device types have

been placed in Class II. The unanimous opinion,

however, is that except for a small number of device types, performance standards cannot be developed in a timely fashion. Thus, if an intermediate class of regulation is still needed, performance standards will have to be replaced by

other types of regulation between Class I and its

good manufacturing practices requirements and

Class 111 and its premarket approval requirements.

Option 13: Give FDA legislative authority to use

available methods in addition to performance

standards to regulate Class II devices.

An obstacle to the use of methods for regulating Class II devices other than performance standards has been the question of whether or not the

law requires the use of performance standards.

GAO has in fact suggested that the law be revised

to give FDA the authority to make a device-bydevice determination of when performance standards are needed (331). Although the use of performance standards may not be mandatory, a

change in the statute clearing up the ambiguity

might be useful in setting into motion substantive efforts to use other approaches, instead of

continuing to focus attention on the unrealistic

expectation that so many performance standards

can be developed.

FDA has suggested using a combination of

voluntary standards, user education, and other

existing controls to regulate Class II devices (387).

Previously identified controls include revoking

any approval to market a device, banning the device, or requiring repair, refund, or replacement,

and the prescription and restricted device provisions. If the legality of using available approaches

in place of performance standards is upheld or the

use of these remedies legislated, a three-tiered regulatory system for medical devices can be put in

place. Rather than a Class II with mandatory controls, however, there would be specific devices

(Class I or Class III) for which additional controls

could be stipulated (e.g., prescription or restricted

devices), and device-by-device determinations of

the applicability of these other controls.

Option 14: Legislate an additional category of

Class II devices to be regulated through methods other than performance standards.

The Subcommittee on Oversight and Investigations of the House Committee on Energy and

Commerce has suggested that performance standards be retained for Class II and that a Class 11A

be formed on which greater controls (e.g., restrictions under the restricted device clause, increased

mandatory device experience reporting, and adoption of performance specifications against which

the device must be tested periodically) are imposed

(338).

This option is similar in effect to the previous

option, the principal difference being that this option involves legislating an explicit, additional category of Class II devices and retaining mandatory

performance standards for some devices. Also,

this option would leave less discretion to FDA in

determining which devices should be regulated

and how they should be regulated.

Option 15: Encourage FDA to reclassify most

Class II device types into Class I or III and to

continue to develop performance standards for

the remaining Class II devices.

Rather than being regulated through performance standards, medical devices receiving Class
132 . Federal Policies and the Medical Devices Industry

II designation are currently being regulated by

FDA as though they were Class I devices. A partial approach to the problem might be to screen

current Class II devices to see whether some of

them could be placed in Class III. This issue was

raised by the Health Research Group in the case

of General and Plastic Surgery devices, when FDA

proposed placing seven implantable device types

(including artificial ears, noses, and chins) in Class

II rather than Class III (253).

The burden of regulation under Class III for

reclassified Class II devices might not be onerous.

FDA already differentiates between “significant

risk” and “nonsignificant risk” Class III devices

in its IDE regulations; and FDA could develop different levels of evidence for safety and effectiveness of the types previously discussed under options for preamendments Class III devices (Option

6).

Postmarketing Monitoring and Controls

The lack of information on risks associated with

the use of medical devices can be viewed either

as evidence that such risks are not extensive and

that more vigorous device regulation is not needed,

or instead as an indication that monitoring systems should be improved to yield more information before risks are discounted. Identifying problems is crucial in determining which devices may

need additional controls and what types of controls should be applied. Thus, improved information on risks would be helpful both for determining the scope of the problems that regulation could

address and in applying the appropriate types of

controls.

Option 16: Require FDA to develop better systems for monitoring and providing information

on risks associated with devices.

FDA is reportedly ready to make final its regulations on mandatory device experience reporting by manufacturers, subject to the Office of

Management and Budget’s approval (257). GAO

has suggested that FDA’s voluntary reporting system, the Device Experience Network (DEN), be

revised so that information is included on the

scope and nature of device problems caused by

user error and inadequate maintenance; that the

data be analyzed to identify special problems and

trends; and that the results be used to aid in developing solutions (331). GAO is also initiating

a comprehensive exploration of postmarketing

surveillance activities and their potential applications (300).

Thus, there is a gradual movement toward better identification of, and faster and more targeted

responses to, device risks. The process might be

accelerated by legislating mandatory device experience reporting instead of continuing with the

permissive language contained in the statute.

Option 17: Encourage FDA to selectively apply

postmarketing controls to regulate Class II

devices.

Postarnendments controls could be applied to

a new class of Class II devices or left to be applied by FDA on a device-by-device basis (see Options 13, 14, and 15). A reconstituted three-tiered

classification approach would result. Minimal regulation would apply to the lowest class of devices

through the good manufacturing practices regulations. An intermediate class of devices (Class

II) would be represented by those devices that

have additional controls (prescriptions, restricted

devices, postmarked controls) applied to them of

the types identified in addition to the good manufacturing practices requirements. The highest

regulated class of devices would have to meet

premarket approval requirements and might have

additional controls imposed on their marketing.

Assistance to Small Manufacturers

The 1976 amendments contained a provision

to help small firms through the regulatory process by establishing an Office of Small Manufacturers Assistance. Two other steps could aid small

firms in manufacturing Class III devices: 1) where

appropriate, Class III devices could be downclassified as soon as possible; and 2) small firms

could be given assistance in developing the safety

and effectiveness evidence necessary for Class III

device approval.

Option 18: Develop additional mechanisms to

help small firms through the regulatory process.

Option 18A: Encourage FDA to use publicly

available information as soon as possible to

down-classify Class III devices.
Ch. 5—Regulation of Medical Devices by the Food and Drug Administration ● 133

— ..—. —

FDA could take the initiative in identifying

Class III devices of significant importance to public health and could monitor their use. Thus, publicly available information could be accumulated

at the earliest possible time and down-classification could be initiated.

Option 18B: Develop a “broker” mechanism between small firms with promising devices and

clinical investigators capable of performing the

tests necessary to gather safety and effectiveness data in support of the premarket approval

application for Class III devices.

Although Option 18A might help small firms

gain approval for medical devices that are already

on the market, it would not help small firms that

want to be among the first to have their devices

approved for marketing.

There is some precedent for a broker function,

although there might be questions of conflict-ofinterest if FDA assumed the role. One precedent,

for example, is the past and continuing collaboration between commercial sponsors and specific institutes at the National Institutes of Health in performing clinical trials for potentially significant

new drugs to meet FDA’s requirements of clinical testing for premarket approval. Another precedent is the Federal promotion of “orphan” medical products, in which Federal funds are used to

support clinical trials for promising products that

have a limited market, such as drugs for rare diseases. Thus, as a broker, FDA could maintain a

registry of potentially marketable devices and provide it to interested parties.
Regulation of the Providers

of Medical Device Devices

For the general run of consumer goods the buyer is necessarily an amateur

while the seller is a professional —Joan Robinson
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

Federal Regulation of Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

Federal Regulation of Providers Under Medicare . . . . . . . . . . . . . . . . . . 137

Federal Health Planning Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143

State Regulation of Providers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

State Licensure of Facilities and Personnel . . . . . . . . . . . . . . . . . . . . . . . . . 145

State Certificate-of-Need Laws . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 147

Discussion and Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 151
6 ■

Regulation of the Providers

of Medical Devices

INTRODUCTION

Regulation in health care has developed because

of certain conditions that set the health care field

apart from many others. Large segments of the

American public do not have sufficient medical

knowledge to make informed decisions about their

health care. To a significant extent, therefore,

especially in the case of sophisticated procedures

and unusual medical conditions, patients must

rely on the judgment of physicians or other health

care professionals. Furthermore, as described in

chapter 3, the system of third-party financing for

medical care that has evolved in this country has

fostered the uncritical adoption and sometimes excessive use of medical technologies, including

medical devices. Such adoption and use, in turn,

have contributed to a rapid rate of increase in Federal expenditures under programs such as Medicare and Medicaid and in national health care expenditures generally.

Chapter 5 discussed the Food and Drug Administration’s regulation of drug and device manufacturers to protect the public from unsafe and

ineffective drugs and medical devices. This chapter

examines regulations pertaining to the health care

institutions and individuals—i.e., hospitals, nursing

homes, home health agencies, ambulatory surgical centers, clinical laboratories, and others—that

provide or use major medical equipment, such as

computed tomography (CT) scanners, or smaller

devices, such as sutures or splints.

Various Federal and State regulatory programs

affect the providers of medical devices. As noted

in the discussion that follows, regulation of health

care providers has been undertaken with several

objectives in mind:

●

●

●

that people receive care of acceptable quality,

that rising expenditures on health care are

controlled, and

that the distribution of medical facilities is

equitable.

This chapter analyzes the impact of Federal and

State regulation of providers on adoption and use

of medical devices in specific health care delivery sites. It also discusses interactions among the

regulations and proposed changes. Although decisions to adopt and use medical devices are typically made by physicians, most of the regulations

discussed in this chapter affect physicians only indirectly.

FEDERAL REGULATION OF PROVIDERS

At the Federal level, providers of services to

Medicare beneficiaries are regulated through conditions of participation, section 1122 of the Social

Security Act, and professional standards review

organizations (PSROs) (currently being replaced

by the utilization and quality control peer review

organizations, PROS). Providers are also regulated under State laws required by the Federal

health planning program.

Federal Regulation of Providers

Under Medicare

Designers of the Medicare program wanted to

ensure that the Federal Government paid for good

quality care for elderly and disabled people eligible for benefits under this program (107), and

conditions of participation for providers were

adopted at the outset of the program to attain a

137

25-406 0 - 84 - 10
138 ● Federal Policies and the Medical Devices Industry — . .

satisfactory level of quality. As the program was

implemented and costs rose, cost containment also

became an issue. Thus, in the Social Security

Amendments of 1972 (Public Law 92-603), both

to help ensure beneficiaries’ access to quality medical care and to help contain costs, Congress created the PSRO program and added section 1122

to the Social Security Act. Along with conditions

of participation, PSRO review of the utilization

and quality of services provided to Medicare beneficiaries and section 1122 review of capital expenditures are described further below.

Conditions of Participation

Conditions of participation are requirements

that must be met by hospitals and other providers

in order to receive payment for treating Medicare

or Medicaid patients, The purpose of the conditions is to assure a basic level of quality of the

medical care for which the Federal Government

pays (107). The conditions of participation for

hospitals are similar to the voluntary standards

promulgated by the Joint Commission on Accreditation of Hospitals (JCAH) (see box L) or the

American Osteopathic Association. About 5,200

hospitals accredited by JCAH or the American

Osteopathic Association are automatically considered in compliance with Medicare quality

standards. However, an additional 1,495 hospitals are not accredited by either of these organizations but do participate in Medicare or Medicaid (315).

Some conditions of participation for providers

list specific medical devices whose availability is

required. The lists of devices in conditions of participation are generally not extensive or exhaustive, but instead allow providers flexibility in

deciding which services to make available. Hospital operating suites, for example, must have the

following equipment available: call-in system, cardiac monitor, resuscitator, defibrillator, aspirator,

thoracotomy set, and tracheotomy set (42 CFR

405.1031 (a) (11)). Freestanding ambulatory surgical centers must provide laboratory and radiologic services that include, but are not limited to,

such medical devices as surgical dressings, splints,

casts, appliances, materials for anesthesia, and

diagnostic or therapeutic services directly related

to the provision of surgical procedures (42 CFR

416.46 (C)).

The conditions of participation have not undergone any substantial revision since Medicare

began operating in 1966. Revisions proposed by

the Department of Health and Human Services

(DHHS) in January 1983 would make the conditions of participation for hospitals less prescriptive, allowing hospital medical staff and administrations greater flexibility in the provision of

inpatient medical care. Statutory requirements are

still included, but the proposed changes “. . . are

intended to simplify and clarify requirements, to

focus on patient care, to emphasize outcome

rather than the means used to achieve those ends,

to promote cost containment while maintaining

quality care, and to achieve more effective compliance with Federal requirements” (315). Beneficiary and labor groups have protested the new

regulations, and the Secretary of Health and

Human Services has delayed publication of the

final rules by returning them to the Health Care

Financing Administration (HCFA) (452).

Many of the existing conditions of participation for providers specify educational and experience requirements for personnel, similar to JCAH

standards. Stringent personnel requirements can

have several effects on the diffusion of medical

devices. Requirements for highly trained (and

therefore often expensive) personnel to perform

certain tasks give providers such as clinical laboratories incentives to purchase capital equipment

that reduces the number of personnel required to

perform the task (provided the available personnel are already being used efficiently) (120,227).

If such capital equipment is expensive, hospitals

and facilities that provide services to inpatients

must comply with section 1122 of the Social Security Act and State certificate-of-need (CON) regulatory programs required by the National Health

Planning and Resources Development Act of 1974

(Public Law 93-641). These Federal and State programs, discussed further below, were responses

by policymakers to several problems: the duplication of facilities and services, which contributed

to the high cost of health care; access to health

care, especially as it pertained to the maldistribution of services; and the high cost of medical care
lkx L.–--jaw On of $

T3w stamliwds for tbt wwe adopted for the hkdiea~e pragram in the Social fkurity of %96$ were based on the 1965 standards for qwdity by JCAH. Con-

- had Kqco imd the need for a quality assurance for the medical care to be paid through

imd ed%aid, Rand the available and acceptable to medical pmfessimmls

alla the publi~ (107).

}~~~a~ WI a~%~~wth Of the ~ospi$a~ a~cr~ditati~~ program initiatd by the American CoIlege

of Ekrgw.ms in 1918 to ensure that hospitals had the necessary equipment and supplies for good quality

patient cam In 1951, the flmmcial burden of stamktrd setting and faciiity mrveying proved too great

$CW the Amwicart Cokge of Surgeons. JCAH was founded that yew by joirdng the American College

of !iiurgeuns, American CcWege of Physicians, American Hospital Association, Ammican Medical Association, and the Canadian Medical Association for the purpuse of accrediting hospitals. The Canadian

Medical Asso&&ion withdrew in 1959, when it formed the Canadian Council cm Hospital Accreditation. The American Dental Association joined JCAEI as a corporate member in 1979.

, Hospitals must be in substantial compliance with JCAH standards in order to be accredited for a

period of 3 years. They must dwmmstrate through a survey process that they m+wt the applicable stzmdard~, ~ither through the hospital’s own facilities artd staff or by sharing some outside services. Shared

ser+kws may be contmcted for with another am-edited hospital or an ~gemy that rnaintsins the level

of performance required by JCAH stmdwxk Each hospital must agree ta conduct an interim self-survey

at the midpoint between its JCAH survqys.

The 1965 JCAH standards adopted by Medicare for its conditions of participation included the requirement d urirdysis and hernogkkin or lwrnatocrit tests for a~l patients upon whnisskm. This requirement contributed to the overuse of tests and the medical devices involved in performing them. In

the e+wly 19?(M, this standard was ekxdnated, and in 1979, JCAH reinforced the principle of “no standing tests” in a to its hospitals (222).

In gerwtd, JCAH standards do not specify medical devices that must be available in hospitals for

rather, the medical staffs at the !mspitak are left to decide about particular medical device s

that will assist in #he provisicm of qwdity cam+ In certain instances, swch as the aner~ency service/department, patient safety requirements specify medical devices and their maintenance. 1%~ example, the

1983 Accreditation Manual fur Hospitals specifies in Standard 11 for Functional Safety and Sanitation:

MAwds anti frequency of testing, and verification of performance —-specifications and me+specifications,

for all electrical imd electronic patient care equipment, based upon established safety requirements, performance

criteria, and manufacturers’ claims. Such testi~ and verification shall apply to both fixed and mobile ~uipment,

with pmDticAw emphasis OR life-suppur$ such as respirators, defibrilktors, pRysic@ic monitoring systems,

iniant incubators and warmers, as well as devices with a high hazard potential such as dectrosurgical

W@prri6?nt . . . *

is an ongoing process in JCAH, and input is sought from specialty organizations,

other experts in applicable areas, and reknwmt government agencies (such as the Health Care Financing

which oversees Medicare). JCAH develops standards in response to identified needs to

measure quality of a service or a particular aspect of care. New or revised standards may be needed

when there am “. , . innovations in techniques, advancements in knuwkdge, changes in gmwrmwmtal

regulations, or the demand by consumers far accountability. . . .“ (IX$. The use of experimental devices,

unlike experimental drugs which am addrewed by JCAH, is not covered by a specific standard (222).

The assumption underlying the vd.mtary JCAH standards is that a rmxsary but mot sufficient condi~iun for good quality medical cam is the availability of certain facilities, including medical techrwlagies and staff. JCAH strives for the following characteristics for its stardards: 1) validity, meaning that

the stwwiards relate to quality of care; Z) encouragement of excellence within available resources; 3)

meanirtg that the standards have been met by an existing hospital; and 4) rrwasurability

{176). The effect of JCAH standards cm the quality of care delivered in hospitals is %uwcdotd. Quality

has improved, but a direct causal relationship has not been established.
140 • Federal Policies and the Medical Devices Industry

borne by Medicare and Medicaid. The interaction

of various Federal and State regulations for independent clinical laboratories is described in box

M.

The effects of Medicare conditions of participation on the adoption and use of medical devices

are unclear. Initially, there was an impetus for the

Federal Government to approve as many hospital beds as possible so that the Medicare guarantee of access to medical care for elderly people

would be operational on the first day of the program’s implementation (7,107). In some cases,

hospitals that had not previously been accredited

because of failure to meet “contemporary standards of technology, staffing, and medical practice” were certified by Medicare as “in substantial compliance” (107). The incentives for facilities

to achieve full compliance were weak, because

hospitals with conditional certification were paid

on the same basis as those in full compliance.

Since Medicare conditions of participation for

hospitals were based on JCAH accreditation standards, any evidence on effects of the voluntary

JCAH standards would apply to these conditions

as well. Unfortunately, there is little evidence that

accreditation has had an impact on the quality

of care in hospitals or on the adoption of new

medical technologies (227). Whether or not the

conditions of participation affect the adoption and

use of specific medical devices is impossible to

prove because of the general lack of specificity

regarding medical devices in most of the conditions of participation (and in the JCAH standards). Data sources for comparisons also lack

specificity regarding medical equipment.

Medicare’s diagnosis related group (DRG) based

prospective payment system for hospitals, which

was mandated by the Social Security Amendments of 1983 (Public Law 98-21) and is currently

being implemented (see ch. 3), changes the environment for Medicare-based regulatory programs.

Medicare’s DRG hospital payment system may

enhance the importance of conditions of participation for quality of care. The same law that mandated DRG payment also added a new “condition of payment”: In order to be paid for treating

Medicare patients, hospitals must contract with

PROS (see “Utilization and Quality Review Programs” section below).

Utilization and Quality Review Programs

Utilization review programs in hospitals have

been a condition of participation for hospitals participating in Medicare since the program’s inception in 1966. In the original Medicare legislation,

hospitals were required to have periodic reviews

of the medical necessity of admissions, extended

stays, and professional services rendered (42 CFR

405.1035 (a)). The purpose of these reviews was

to help contain costs and to ensure quality of care.

Medical device use was to be evaluated in connection with the review of professional services.

Congress mandated the PSRO program in the

Social Security Amendments of 1972 (Public Law

92-603) to carry out these utilization and quality

review responsibilities. PSROs, which as noted

above are currently being replaced by PROS, are

areawide groupings of practicing physicians designated by DHHS to review services provided to

Medicare and Medicaid beneficiaries. Their purpose has been to ensure that the services Medicare and Medicaid pay for are: 1) medically necessary, 2) of a quality that meets locally determined professional standards, and 3) provided at

the most economical level consistent with quality

of care. Thus, the two objectives of the PSRO program have been quality assurance and cost containment (345).

In theory, PSROs were to accomplish these

goals by conducting three types of evaluations in

inpatient hospital settings, long-term care facilities,

●

●

●

and ambulatory care settings:

utilization reviews (e.g., reviews of the length

of stay and medical necessity of admissions);

medical care evaluations or quality review

studies (e.g., audits of patient records to

monitor the appropriateness of tests, drugs,

and procedures administered to patients);

and

profile analyses (e.g., reviews of hospital

physicians’ patterns of care to identify potential problems).

in practice, PSROs have tended to emphasize

utilization reviews in inpatient settings, focusing

on the identification of high hospital admission

rates and lengths of stay. One of the reasons is

that identifying high usage of hospital care has

proved easier than identifying underuse of hos-

142 • Federal Policies and the Medical Devices Industry

pital care or specific medical technologies. Furthermore, from the standpoint of reducing Medicare costs, reducing overutilization of hospital

admissions and lengths of stay is clearly important. Reducing overutilization of hospital care is

likely to be more cost saving than reducing underutilization, although it could be argued that from

the standpoint of quality assurance, it is also important to consider the latter.

PSRO utilization reviews in hospitals, although

not focused on particular drugs, devices, or medical procedures, may nevertheless have indirectly

affected the utilization of specific medical devices.

Quite conceivably, changes in hospital admission

rates and lengths of stay may have indirectly affected the use of diagnostic tests and other devicebased procedures routinely used for hospital

patients.

Like PSRO utilization reviews, most medical

care evaluations and profile analyses have been

conducted by PSROs in inpatient hospital settings.

Unlike utilization reviews, however, some medical care evaluations have been directly focused

on the appropriate use (including underutilization)

of specific medical devices.

Thus far, evidence on the effectiveness of review programs has been mixed. Analysts considering benefits of review programs have examined

both cost savings and contribution to quality

assurance. Evidence is inconclusive that utilization review programs have achieved net cost savings when reductions in length of stay and admissions are considered along with the costs of the

review program (50,57,325,326,334,395,397,409,

411). Evidence that review programs have improved quality of care is limited but suggestive

(57,395).

No specific evidence of the effects of PSRO or

hospital review programs on the adoption and use

of medical devices has been reported, although

a study of one hospital showed that length of stay

and average charges per patient (probably related

to medical device use) generally decreased following institution of PSRO review. The decrease,

however, did not result in savings to Medicare

and Medicaid because of an increase in hospital

admission rates also attributed to PSRO review

(455).

As noted earlier, the Social Security Amendments of 1983 added as a new “condition of payment” for hospitals treating Medicare patients the

requirement that hospitals contract with PROS.

PROS have responsibility for monitoring ancillary service use and hospital discharges that result in quick readmissions, because Congress recognized the financial incentives under DRG prospective payment to use as few ancillary services

(including those involving medical devices) as possible, to discharge Medicare patients as quickly

as possible, and to admit as many cases as possible.

PROs, the replacements for the PSROs, are

contract organizations that must affirm their utilization review and quality assurance objectives,

as well as define their specific plans on how to

attain these objectives, in their contracts with

HCFA. Medical devices will be subject to evaluation under the PRO function to review the completeness, adequacy, and quality of care to hospital inpatients. A specific requirement in the

scope of work for PROS is to monitor cardiac

pacemaker implantations and reimplantations for

unnecessary procedures (407).

Section 1122 Capital Expenditure Review

Section 1122 of the Social Security Act and

State CON laws required by the National Health

Planning and Resources Development Act (see

“Federal Health Planning Regulations” and “State

Certificate-of-Need Laws” sections below) potentially could have the most direct effect on medical devices of any of the provider regulations discussed in this chapter. Congress mandated section

1122 capital expenditure review in the Social Security Amendments of 1972 (Public Law 92-603).

The purpose of section 1122 review is to ensure

that Federal funds for Medicare, Medicaid, and

the Maternal and Child Health and Crippled

Children’s Services programs are not used to support unnecessary capital expenditures by health

care facilities. Section 1122 of the Social Security

Act authorized the Secretary of Health, Education, and Welfare (now Health and Human Services) to enter into contracts with States that were

willing and able to do so. Under these contracts,

a State or State health planning agency would review expensive capital expenditures, and the Sec-
Ch. 6—Regulation of the Providers of Medical Devices ● 143

 . . —

retary could withhold reimbursement for expenditures that were disapproved.

Under section 1122, capital expenditures by

specified health facilities that exceed a certain

threshold—initially $100,000, currently $600,000—

are subject to review by a State or State planning

agencies. Also subject to section 1122 review are

changes in numbers of beds or substantial changes

in the services offered in medical care facilities.

As of 1983, only 15 States had contracts with

DHHS to conduct section 1122 capital expenditure reviews.

Section 1122 currently applies to hospitals,

psychiatric hospitals, tuberculosis hospitals, skilled

nursing facilities, kidney disease treatment centers,

intermediate care facilities, and ambulatory surgery centers. Medicare and Medicaid reimbursement to these facilities can be denied only for

unapproved capital expenditures (i. e., expenses

related to depreciation, interest on borrowed

funds, or, in the case of proprietary facilities, return on equity for capital equipment or construction). Reimbursement for operating expenses associated with unapproved capital equipment or

construction is not affected.

Because of the high threshold for section 1122

review and the State-based decisionmaking process provided for in the law, the effect of section

1122 provider regulation on medical devices is

probably similar to that of the State CON programs required by the National Health Planning

and Resources Development Act of 1974 (see section on “State Certificate-of-Need Laws” below).

Only a few devices-e. g., CT scanning and nuclear magnetic resonance (NMR) equipment—exceed the threshold for section 1122 review. Thus,

most purchases of medical devices by the facilities to which section 1122 applies can be made

without section 1122 review.

Federal Health Planning Regulations

Bringing together several strands of previous

legislation, the National Health Planning and

Resources Development Act of 1974 (Public Law

93-641) outlined national health priorities and

replaced the existing network of voluntary agencies with a system of about 200 local health systems agencies and State health planning and development agencies. The purpose of this act and

related health planning legislation was to centralize decisionmaking at the State level in order

to rationalize resource allocation and control

escalating rates of cost increases.

The 1974 law called for the provision of greater

authority to State and local planning agencies over

hospital investments. The law required State

health planning agencies to review CON and section 1122 applications from medical facilities

regarding capital investments. State planning

agencies have the responsibility of determining the

numbers and types of facilities and services needed

by their populations. State Health Plans to accomplish the equitable distribution of these health care

services are required by the Federal law. Agencies try to alleviate the perceived maldistribution

of health services and to contain rising costs

through CON programs.

Amendments to the 1974 National Health Planning and Resources Development Act established

a two-level review process for CON programs.

A medical facility must submit a detailed application to the local health planning agency, which

subsequently reviews it. State health planning

agencies have the authority to grant a CON, but

they must carefully consider the recommendation

of the local agency.

Minimum criteria and standards for CON review by the States are set forth in the Federal planning law. The State agencies must consider the

relationship of the proposed services to the State

health plan and to the provider’s long-range plan,

the targeted population’s need for the proposed

services, alternative means of meeting the need,

the availability of resources for the proposed service and alternative health uses of those resources,

the relationship of the proposed service to the existing health care delivery system, and special

needs of health maintenance organizations (HMOs),

among other criteria.

Current Federal law requires hospitals, skilled

and intermediate-care nursing facilities, kidney

disease treatment centers, rehabilitation hospitals,

and freestanding ambulatory surgical centers to

submit applications for capital expenditures under

State CON programs. States vary in their cover-
144 ● Federal Policies and the Medical Devices Industry — — .

age of other facilities, but few cover physicians’

offices (see section on “State Certificate-of-Need

Laws” below). Some facilities are exempt from the

Federal requirement for CON applications for

capital equipment, among them Federal hospitals

and clinics (e.g., Veterans Administration medical centers). Medical research institutions and

HMOs are given special consideration. These entities must notify the State CON agency that they

intend to purchase a piece of major medical equipment, for example, and the agency must approve

the purchase if specific applicant criteria are met

and if need is demonstrated (Public Law 96-79 and

Public Law 96-538).

Required applications for CON are triggered

under Federal law by types of expenditures and

by amounts of such proposed purchases. Proposed expenditures must: 1) exceed the threshold,

2) substantially change the bed capacity of the facility, or 3) substantially change the services of

the facility. The original CON thresholds were:

1) $150,000 for capital expenditures, 2) $75,000

for annual operating costs resulting from changing services, and 3) $150,000 for major medical

equipment to be used to provide medical and

other health services. The CON threshold levels

that have been in effect since 1981 are: 1) $600,000

for capital expenditures, 2) $250,000 for annual

operating costs resulting from changes in health

services, and 3) $400,000 for major medical equipment to be used to provide medical and other

health services.l For changes in health services,

CON applications are required if there is any capital expenditure or if annual operating costs exceed the specified operating cost threshold (129).

Medical device purchases are included in CON

applications in those instances in which the devices are very expensive or in which facility services are changed.

Since 1979, Federal law (Public Law 96-79) has

required purchases of major medical equipment

that will be used for medical treatment of hospi-

. .

1

States have been given authority to adjust these thresholds to

reflect the change in the previous year in the Department of

Commerce Composite Construction Cost Index. For States that do

so, the thresholds would be $695,285 and $289,782. The $400,000

threshold for major medical equipment may not be adjusted. (See

Public Law 97-35 or proposed rule changes in the Jan. 4, 1983, issue

of the Federal Register (315). )

tal inpatients to be covered by State CON laws,

regardless of who makes the capital expenditure.

Gifts and donations of medical devices that would

come under CON laws if they had been bought by

the facility are also subject to CON requirements.

Capital equipment initially purchased for research purposes usually must be approved for

later clinical use through the CON requirement

regarding new institutional services. There are no

national data available regarding how much medical equipment has initially been purchased for research purposes and then transferred to clinical

service. Thus, the effect of this aspect of the

CON regulation on the medical devices industry

is unknown.

What are the sanctions or incentives that enforce the Federal planning law’s requirement that

States have CON laws? First, States that do not

have such laws risk losing their Federal planning

money. But Federal planning funds have decreased

over the past few years, and the program has

weakened. Second, and probably more important, if States do not have conforming CON laws,

they are supposed to lose Federal funds from several Public Health Service programs (particularly

those under the Community Mental Health Centers

Act, Comprehensive Alcohol and Alcoholism Prevention, Treatment, and Rehabilitation Act of

1970, and the Drug Abuse Office and Treatment

Act of 1972–see Public Law 96-79, sec. Ids).

The threat of these sanctions persuaded all but

one State (Louisiana) to pass CON laws by March

1983 (406), although as of March 1984, only 23

States had CON programs in compliance with the

minimum Federal requirements (129). Because the

sanctions are not being applied under the present

national law, however, Minnesota, Idaho, and

New Mexico have allowed their CON laws to expire, For several years, the costs and benefits of

the Federal planning program have been questioned by Congress. This debate has resulted in

funding the planning program through continuing resolutions that have specified that noncomplying States not be penalized.

The future of the Federal planning program is

uncertain. Budget decreases and the expressed intention of the Reagan Administration to dismantle planning have further weakened the existing
Ch. 6—Regulation of the Providers of Medical Devices ● 145

Photo credit: General Electric

Nuclear magnetic resonance (NMR) imaging equipment,

shown here, is one of the few medical devices that is

expensive enough to be regulated under State

certificate-of-need (CON) laws.

program. The Administration, however, seems to

be reconsidering its position (453). New CON

thresholds have been proposed in Congress (see

box N), and the Office of Management and Budget

has indicated a willingness to accept thresholds

of $5 million for capital expenditures, $1 million

for changes in institutional health services, and

$2 million for major medical equipment (453). Although the fiscal year 1985 Federal budget contains no funds for health planning, the Administration has indicated that new, reasonable legislation

would be considered favorably (37).

Health planning has many critics, but an indepth examination of the pros and cons of health

planning is beyond the scope of this report. Specific criticisms of the Federal health planning program focus on the difficulty of determining the

need for various health facilities and services.

Methods of calculating need involve the use of

demographic and epidemiologic data and require

decisions based on the pros and cons of having

excess or insufficient facilities on a periodic or

sporadic basis. State and local planning agencies

often rely on hospitals and other facilities for their

data, which may pose problems of reliability. In

considering the need for new medical technologies, data may not be available. State planning

agency staffs may not have information on safety,

efficacy, and cost effectiveness of new or old medical devices. Furthermore, agency personnel have

been criticized for their lack of ability to use the

data appropriately (61,111).

The effect of the Federal health planning regulations on medical devices is most distinct in the

CON impacts examined in the section on “State

Certificate-of-Need Laws” below.

STATE REGULATION OF PROVIDERS

At the State level, providers of medical devices

are regulated in part through State licensure laws

for facilities and personnel. They are also regulated through State CON laws, which are required

by the Health Planning and Resources Development Act of 1974 (Public Law 93-641) to conform

to Federal criteria. Capital expenditure reviews

required by section 1122 of the Social Security Act

were discussed in the section on “Federal Regulation of Providers” above. Although like CON reviews, section 1122 reviews are State based, the

sanctions on facilities for noncompliance with the

section 1122 are the withholding of Federal funds

under Medicaid, Medicare, and Maternal and

Child Health and Crippled Children’s Services

programs. The sanctions on facilities for failure

to comply with CON, by contrast, are determined

by individual States.

State Licensure of Facilities

and Personnel

States have the power and responsibility to determine which providers may treat patients. To

ensure a minimum level of quality for providers,

State laws require hospitals, nursing homes, and

other health care facilities to meet specific standards in order to be licensed to operate. Facility
146 ● Federal Policies and the Medical Devices Industry

. . — . . .

standards often include staffing requirements for

licensed personnel who have met a set of licensure qualifications, such as education and experience. Virtually all States have hospital licensure

laws, but licensure laws with respect to other types

of facilities vary. State licensure laws also vary

according to types of personnel The specific

standards and qualifications required are decided

by the individual States (227).

Some licensure laws are more detailed than

others regarding medical devices or, more frequently, necessary staffing and staff qualifications licensure laws are similar to the Medicare

conditions of participation in their focus on structural aspects of quality assurance, such as compliance with construction codes and public health

laws licensure regulations tend to be weaker,

more ambiguous, and not so well enforced in mat-
Ch. 6—Regulation of the Providers of Medical Devices ● 147

ters that are more clearly related to patient care

(227).

There has been little research on the influence

of State licensure laws on the adoption and use

of new medical technologies (227). It is probable,

however, that licensure programs have had mixed

effects on medical devices, depending on the specificity of the individual laws and how a particular device is related to personnel needs. In clinical laboratories, for example, the strict personnel

requirements for laboratory licensure make equipment that reduces the number and skill level of

personnel quite attractive (120).

On the other hand, licensure requirements may

slow the diffusion of equipment that requires licensed personnel for operation (227). In addition,

stringent rules to employ highly trained personnel in laboratories raise barriers to entry of new

facilities in the market because of the difficulty

of finding and expense of employing the required

personnel (120). Both facility and personnel licensure, then, can affect medical device diffusion.

Another characteristic of State licensure programs themselves that probably affects the medical devices industry is the use of professional

surveyors to inspect facilities. The subjectivity of

some of the judgments needed to decide about

licensing a facility can sometimes be the basis for

challenging negative outcomes. Also, if review

teams have a particular professional orientation,

they can encourage the adoption of the best available new equipment (227).

State Certificate-of-Need Laws

Several States had CON laws prior to the enactment of the National Health Planning and Resources Development Act of 1974. In 1964, New

York became the first State to enact and implement a CON law. Twenty-seven States had CON

laws by the time the National Health Planning Act

was passed. These States were required by 1980

to make their laws conform to the same minimum

Federal standards as State CON laws enacted after

1974 (Public Law 96-79 ).2 However, State CON

‘Costs and benefits of the Federal health planning program have

been debated in Congress for several years. This debate has led to

budget cuts and to continuing resolutions that do not enforce

penalties on noncomplying States.

laws differ with respect to the types of facilities

covered, the standards and criteria used for CON

review, and the amounts of the expenditures for

which CON applications must be submitted (406).

As noted in the “Federal Health Planning Regulations” section above, current Federal law requires hospitals and other specified medical facilities to submit applications for capital expenditures under State CON programs. Some States

require other types of facilities (e.g., freestanding

emergency care centers and home health agencies)

to submit applications, as well. Nine States require CON applications for equipment purchases

for physicians’ offices (453).

The focus of review when CON laws were first

implemented after 1974 was on construction projects (i. e., modernizing old buildings and erecting

new ones) and bed capacity changes (61). One of

the reasons was that control over the costs of such

projects implied control over further duplication

of facilities and excess bed capacity that was

blamed for some of the increase in health care

costs. Another reason for the focus on construction and bed capacity changes when CON laws

were implemented was that there were few medical technologies at the time that cost more than

$150,000 (the original CON threshold). Furthermore, hospitals and other purchasers of medical

equipment were able to circumvent the requirement for CON applications for equipment purchases in excess of the threshold by dividing orders

into smaller expenditures that would not trigger

the review process (42). If new laboratories were

built or old ones renovated, construction was usually necessary and put the project over the CON

threshold. If equipment purchases (regardless of

price) changed the health services offered, or if

the new services (regardless of capital expenditures) resulted in operating costs over $75,000

(again, the original threshold), CON applications

would be required (129).

As CON programs matured and as medical

equipment changed, more medical devices came

under review. Highly innovative machines that

altered the practice of medicine, such as the CT

scanner, were introduced in the 1970s (see box O).

Machines such as CT scanners presented CON

agencies with difficulties because of their high cost
BOX C?. -The Impact of Certificate of Need (CON) on Computed Tomography (CT) Scanners and

Nuclear Magnetic Resonance (NMR) Imaging Devices

Many of the issues encountered in today’s debate regarding the costs and benefits of NMR imaging

devices were also problems encountered when CT scanning equipment was introduced in the 1970s, The

CON laws were changed to balance some of the incentives for CT, but their effect on NMR remains

speculative.

One of the difficulties in the CON process for CT scanners was the lack of data on safety and efficacy for different medical conditions when CON applications were received (348). Physicians were

experimenting with new uses of the machines, and manufacturers were improving the images and reducing the X-ray dosage for their machines. Some hospitals obtained CT scanners for investigational purposes, and when CON applications were later submitted, these institutions already had the machines

and experienced personnel on staff. Furthermore, some CT scanners were purchased for hospitals by

physicians or groups of physicians, since only hospital purchases were covered by most CON laws. Mobile

CT units were also purchased and were able to serve several hospitals (349).

In 1979, CON laws were amended to include major medical equipment purchases for inpatient hospital use regardless of purchaser (Public Law 96-79). This change affected the private purchases of CT

scanners for hospitals and the mobile units. Private purchases for nonhospital locations of CT scanning

devices were exempt from most States’ CON programs, The CON laws may thus have contributed to

the maldistribution of CT scanners that was perceived as late as 1980 (23). The maldistribution of scanners has implications for access to care and perhaps for quality of care for the poor segments of the

population who most often go to the hospitals that were not able to obtain CT scanners.

The price of head scanners declined over time, and hospitals that had waited to purchase them could

do so without submitting CON applications because prices fell below the threshold. A change in the

Federal regulations regarding CON programs in 1979 brought the head scanners back into the planning

fold by using the “change in service” requirement (349). Upgrading equipment from CT head scanners

to body scanners also came under CON review.

NMR imaging devices have been compared to the CT scanning devices because both have been expensive innovations that could change the practice of medicine. Both became popular while still in experimental stages of development. Just as CT head scans were further advanced in development when

CT began to affect CON processes, NMR head images are further advanced than NMR body images.

CON applications were submitted before there were adequate data from which to evaluate CT scanning

equipment (349). Although NMR is still in a research stage, 33 CON applications had already been filed

for NMR by October 1983 (451).

The prices of most NMR devices would trigger CON even if the thresholds were raised to the proposed $1 million for major medical equipment (100). Prices on CT equipment have fluctuated, but whether

or not prices will decrease for some or all NMR devices is unknown. NMR devices would also trigger

CON for changes in service and if construction costs for building or renovating facilities to house NMR

equipment exceed the proposed $5 million CON threshold. Physical facilities must be modified more

for NMR than for CT equipment. Both raise operating costs, and NMR devices require special personnel. When CT scanners first became a CON issue, third-party payment for their use was questionable.

That is the case again with NMR. Private investors are purchasing NMR imaging equipment and locating it at nonhospital sites for the use of ambulatory patients. Thus, although NMR device use is still

in a research phase, there seems to be a considerable amount of action in the market (100).
Ch. 6—Regulation of the Providers of Medical Devices ● 149

and the paucity of data on safety and efficacy.

Physicians were still experimenting with new uses

of CT scanners and manufacturers were still refining their machines when CON agencies received

applications from hospitals and other covered facilities. In some cases, physicians and physician

groups purchased CT scanners for their hospitals,

to circumvent the requirement for CON approval

(which in 1979 was extended to cover any major

medical equipment to be used for inpatient care

without regard to the purchaser or to the location of the equipment) (349).

The interaction of CON thresholds and equipment purchase prices is a potential source of influence on the diffusion of new medical devices.

Over time, CON thresholds have increased. The

prices of medical equipment also change over time

as refinements are made or as components instead

of a composite machine are sold, for example. The

prices of medical equipment may go either up or

down.

If new major medical equipment is priced above

the CON threshold, delaying its purchase may

save a facility money (unless the facility’s resulting

loss in potential operating revenues is substantial):

if the price drops below the CON threshold, the

facility may save not only the amount by which

the price drops but also the administrative costs

of the CON application. In the case of equipment

that substantially changes the services provided

by the facility, however, CON review would be

necessary even if the price were to drop. In addition, facilities are prohibited from dividing projects into parts to avoid CON applications—each

project must be a separate project (141).

Under the Federal requirements, State CON

programs are to “provide for procedures and

penalties to enforce the requirements of the program” (42 U.S. C. 300 m-2). Hospitals and other

covered facilities must submit their CON applications to the State or local planning agency and

abide by the approvals or denials or suffer the

consequences. Sanctions against providers vary

among the States but may include any or all of

the following: denial or revocation of operating

licenses, fines, civil or criminal penalties, and

court injunctions (42 CFR 123.408 (b)).

Studies of the effectiveness of CON programs

have shown that some States have used them successfully and others have not (133,436). Capital

expenditures and health care costs have continued

to increase despite CON laws, although both

results may vary by State (436). Several researchers have studied the effects of CON on capital expansion; some have found evidence supporting

capital limitation by CON and some have found

evidence against it (436).

Studies of the effect of CON on cost control

have produced no findings to support its ability

to control health costs (436). Access to care for

some patients has been improved, but there still

seem to be excess bed capacity and duplication

of services and facilities in some areas and shortages in others, all of which were to have been

eliminated through CON (61).

There have been many studies of the impact of

CON programs on capital expenditures (436). One

of the early studies by Salkever and Bice showed

that in States with CON laws, the number of beds

decreased, but total hospital investment and assets

per bed (which relate to medical devices) increased

from 1968 to 1972 (270).

Hellinger, testing the hypothesis that the

amount of hospital investment in States with

CON laws would be less than it would have been

without the CON programs (148), concluded that

CON legislation had not significantly decreased

capital expenditures. He then speculated that there

would be a lagged effect because hospitals had anticipated the passage of the CON laws and spent

higher than usual sums in the period before their

implementation.

Warner has pointed out that because they do

not specifically consider operating costs associated with capital purchases, CON programs do

not evaluate whether equipment will ultimately

save costs or increase costs (450). Operating costs

of capital expenditures continue to be a source of

health care cost increases (64).

Yet another study showed that in States with

hospital rate-setting programs, increased capital

expenditures may not lead to higher operating

costs (96). Specific devices may be affected dif-
150 ● Federal Policies and the Medical Devices Industry

ferently in different States. Russell found that the

diffusion of cobalt therapy was not discouraged

by the CON law in New York, but CON laws in

other States have discouraged the technology’s

adoption of cobalt therapy (266).

A July 1982 study by the Wisconsin Hospital

Association used data from the Wisconsin Hospital Association CON Data Base, its 1982 CON

Survey, and State and local CON agencies’ grant

applications for 1978-81 to analyze the cost effectiveness of Wisconsin’s CON program (462).

The association found, using particular assumptions, that CON costs far outweighed the benefits.

The investigators concluded that Wisconsin’s

CON program was not cost effective, did not suppress applications for capital expenditures (i.e.,

did not have a sentinel effect), had had its decisions reversed through administrative appeals,

and had been unfocused and inconsistent in the

substance of its reviews and in its determinations.

Looking at application and approval and denial

data gives the impression that CON programs are

accomplishing some of their goals. From 1979 to

1981, States reviewed more than 20,000 CON applications, which totaled more than $31 billion.

Almost 10 percent of the applications were denied,

saving an estimated 15 percent of the proposed

expenditures (406).

These aggregate figures hide the facts that CON

may have deterred an unknown number of applications and purchases and that the quality of

the rejected applications is unknown. Some consultants specialize in CON applications (148), and

manufacturers may send staff to assist hospitals

in their CON applications (208). Small hospitals

with less sophisticated technology are probably

at a disadvantage in attracting or being able to

pay for such help, and this may exacerbate the

maldistribution of high-technology devices. Also

among the unknowns are whether the distribution of services is being made equitably among

the population and whether approved projects

were needed more than those denied.

The costs of the CON programs themselves are

substantial. In 1982, total Federal and State costs

of administering CON programs were $16.9 million (406). Additional costs were probably offset

by the CON application fees charged by half the

States. Application fees and the other costs borne

by the applicant facilities may discourage some

applications. Whether the applications discouraged

are frivolous or important for the health of the

affected population is unknown. It is likely that

examples could be found at either extreme.

Weighing the costs of the CON programs against

their benefits is difficult because of the existence

and interactions of Federal, State, and local regulatory programs and of complex goals. Competing goals, such as the elimination of excess beds

and the assurance of access to health care, not

only present CON programs with problems while

they are evaluating applications, but also exacerbate the problem of identifying and measuring the

benefits of regulation and planning.

CON programs would lose some of their control over capital expenditures if the thresholds

were raised to the levels proposed by the Office

of Management and Budget (i.e., $5 million for

capital expenditures, $1 million for changes in

services, and $2 million for major medical equipment). Clearly, fewer projects would require CON

applications. Even some new facilities would be

below the threshold unless they were specifically

covered by CON laws. New freestanding emergency care centers, for example, have averaged

$634,000 in building, land, and capital equipment

costs (292). Capital expenditures that change institutional services and increase operating costs

by $1 million annually would still require a CON,

but their numbers would probably be small. High

thresholds and the resultant low number of CON

applications would save administrative costs for

Federal and State governments and for the facilities,

If the Federal health planning program expires,

the State CON laws will be voluntary (as far as

the States are concerned). In 1984, the Office of

Health Planning of DHHS has estimated that 37

of the States that have CON laws would keep

them without the Federal requirement (129). A

dozen States have “sunset” clauses that allow the

CON laws to expire on specific dates; some others

have sunset provisions tied to the anticipated demise of the Federal health planning program.

Again, some States have CON laws that are more

stringent and some have more lenient regulations

than the Federal CON requirements.
Ch. 6—Regulation of the Providers of Medical Devices ● 151

The financial incentives for hospitals under

Medicare’s DRG hospital payment system currently being implemented (see ch. 3) change the

roles of the CON laws and the planning program

in general. Some of the effects will depend on how

capital costs will be handled under the DRG system.3 With DRG payment for inpatient operat3Capital costs are now paid on a cost-reimbursement basis but

will probably be paid on a different basis by 1986, since Congress

mandated studies of how to treat capital costs under the DRG hospital payment system (Public Law 98-21). Any new capital payment

method can be expected to change the hospitals’ incentives regarding capital expenditures.

ing costs (capital, outpatient, and direct teaching

expenses remain “passthroughs”), hospitals have

financial incentives to purchase technologies that

lower their operating costs per case; and if they

are expensive, these technologies may come under

CON scrutiny. An anticipated response to the

DRG hospital payment system is the movement

of technologies from tertiary to primary care sites.

This movement may be retarded in States where

facilities other than hospitals are included under

CON. The effect of such movement on costs will

depend on whether the primary sites were replacing or supplementing hospital care and on the extent of total use that results.

DISCUSSION AND POLICY OPTIONS

Regulation of the providers of medical devices

has been undertaken to control medical care costs,

increase access to medical care (including devices),

and control quality of care. Available evidence

on the success that Federal and State regulation

of providers has had in meeting these objectives

is inconclusive. Health care costs continue to rise

at a higher rate than the overall Consumer Price

Index. Access to care is still a problem for some

poor patients or patients in particular locations.

Quality of care is difficult to define and measure,

and problems remain in assessing quality concerns.

Conditions of participation for providers of

services to Medicare beneficiaries and the new

Federal requirement that hospitals contract with

PROS (utilization and quality control peer review

organizations) in order to be paid by Medicare

have quality as well as cost implications. Changes

in conditions of participation proposed by DHHS

in January 1983 would give hospitals more flexibility in the provision of inpatient care, and medical devices may be affected even less under the

new conditions than they were under the original

set of conditions. Efforts have been made in the

PRO regulations issued by DHHS to address previous problems with the PSRO program concerning quality review by requiring that evaluations

of PROS have both cost and quality components.

Evaluations of PSRO programs focused on costcontainment goals without adequately measuring

quality of care. Thus, for example, such evaluations emphasized the ability of PSRO utilization

reviews to decrease length of stay and hospital

admissions.

Section 1122 of the Social Security Act pertains

to review of capital expenditures and the Medicare, Medicaid, and Maternal and Child Health

programs. Few medical devices come under section 1122 review because of the high threshold

($600,000). However, those devices that do also

trigger CON review. The penalty for facilities that

disregard section 1122 reviews would be stronger

if the Social Security Act required the withholding

of Federal program payments for operating costs

associated with unapproved capital investments.

The Federal Health Planning and Resources Development Act requirement that States impose

CON regulations on hospitals and other facilities

in theory should have formed the strongest regulatory mechanism concerning the adoption and

use of medical devices. Although CON regulations have attempted to contain costs and improve

access, the evidence of their effect on medical

devices is inconclusive: it is unclear whether CON

laws have influenced the adoption and use of medical devices.

The results obtained by State CON laws may

reflect certain characteristics of these laws. First,

the laws have high thresholds for capital expend-
152 ● Federal Policies and the Medical Devices Industry

itures resulting in the coverage of few devices

under these laws, and the laws ignore future operating costs. Second, the focus on hospitals by

almost all the CON laws—although other sites are

covered by some States (including physician offices in nine States)—may have contributed to

duplication of technologies within the system.

Third, the lack of a limit on the amount a CON

agency can approve lessens the potential impact

of CON on total costs. Fourth, the CON process

is a reactive process in the sense of being dependent on the submission of CON applications by

medical facilities. And fifth, political interactions

among consumer patients, providers, and CON

agencies influence the decisionmaking process.

One problem with concluding from the mixed

evidence that CON regulations have been ineffective is that incentives for health care facilities

to buy whatever they wanted were embedded in

cost-based reimbursement by third-party payers,

and not all purchases were subject to CON requirements. Duplication of equipment among hospitals and other facilities in the same geographic

area continues at least in part because facilities

want to attract patients and physicians by providing up-to-date equipment. CON programs do

not have the power to decide how much equipment is used or the ways in which it is used. Utilization and quality review programs can encourage

the appropriate use of technologies, but decisions

about use are basically left to physicians (and in

some cases patients).

CON agencies have been hampered by unavailability of data on the health of the population and

on the safety and efficacy of some new medical

equipment, undeveloped techniques for determining need, insufficient budgets to hire appropriate

planning agency staffs, and the political sensitivity

of rationing health care. Furthermore, the regulatory agencies responsible for CON were advised

by committees representing not only consumers

but also the health care providers. CON decisions

were thus compromises among parties with conflicting interests. All these difficulties have been

exacerbated by constantly changing technology.

The following options present a range of possibilities regarding CON programs, from changing current regulations to eliminating them. The

options concentrate on CON because of the relative availability of information on these programs

and because of the direct impact on the medical

devices industry.

Option 1: Expand the National Health Planning

and Resources Development Act to require

State CON laws to cover purchases of medical equipment regardless of setting.

This option would attempt to make the incentives of the Federal health planning act more neutral with respect to the location of certain medical devices by requiring that in addition to the

hospitals, dialysis centers, and other facilities now

covered by the act, physicians’ offices, diagnostic centers, and other facilities now excluded by

the legislation be required to submit CON applications before purchasing expensive medical equipment. Control over all sites of care would remove

current incentives to place expensive devices in

certain, mainly nonhospital, settings without regard to cost effectiveness. Maldistribution of medical equipment might still occur, though, because

of the reactive nature of the CON process and the

influence of other factors on placement.

Several States already have CON programs that

cover major medical equipment purchases regardless of setting or ownership. Some States are encouraging hospitals to share equipment, such as

new NMR devices in Nebraska (291). More sharing would be anticipated if all settings were covered, especially if a State had a limit on total CON

approval. If such sharing became commonplace,

different arrangements might be necessary to ensure quality (349). For example, facilities now

carry liability insurance for their own physicians

to use their medical devices; this type of insurance might have to be extended to other physicians using the devices.

Greater administrative costs to governments

and providers from increasing the number of applications would result under this option. Although few medical devices are covered by CON

thresholds, applications would increase since

many of the settings that would be added by this

option already purchase high-cost medical devices

for which hospitals and other facilities are cur-
Ch. 6—Regulation of the Providers of Medical Devices ● 153

rently regulated. Regulatory staff would have to

learn about health care delivery and needs for

devices in these currently uncovered settings.

Option 2: Amend the National Health Planning

and Resources Development Act to limit the

level of capital expenditures that State CON

agencies may approve in a year.

Because the funds for health care facilities and

medical devices are limited, not all projects can

or should be funded. Current CON approval or

denial decisions are not necessarily made in light

of information on different types of projects, and

tradeoffs are not necessarily considered. A limit

on the level of capital expenditures would necessitate comparisons among projects.

The Federal requirement that CON applications

be batched so that similar projects are evaluated

at the same time does not address the issue of

tradeoffs among dissimilar projects, Hospitals that

want to purchase new CT scanners, for example,

may have to wait several months until the batch

of applications is evaluated. Those applications

are reviewed without regard to applications for

other types of equipment or for buildings.

The Commission on Capital Policy of the American Health Planning Association recently recommended that future cost-based reimbursement for

capital be limited by each State, subject to a Federal standard (5). The commission urged the adoption of limits that reflect the relative need of each

State for modernization of facilities and for new

services and facilities. It further suggested that

capital payments within those limits be allocated

by means of a planning and capital expenditure

review process, presumably similar to the existing

system.

If Medicare’s DRG prospective payment system for hospital operating costs were extended to

other payers, a State limit on total CON approval

would become less useful. The reason is that hospital acquisitions would be constrained by the financial pressures to limit operating costs. A limit

on the level of expenditures a CON agency could

approve would also be less necessary if capital expenditures were included in DRG payments.

A major obstacle to the implementation of this

option is the limit itself. Congress or the Administration might be the decisionmaking body for

choosing the limit, but how would the limit be

chosen? Techniques for determining a community’s need for specific medical devices are still

controversial. Determination of the need for the

total capital expenditure in health care is clearly

problematical. How much is the Nation or each

State willing to pay overall for health care? How

could that amount be apportioned between capital and operating costs, excluding preventive care

for the moment? Would the limit be applied nationally or at the State level or locally? How

should the budgeted limit be apportioned among

the geographic regions or among the health care

delivery sites?

The ultimate problem would be the selection

of individual projects for funding in light of the

lack of a generally valid decisionmaking method

and the lack of theoretical or empirical predictions

that the results of such a limit would be efficient

or equitable.

Option 3: Amend the National Health Planning

and Resources Development Act to eliminate

the Federal CON requirement.

State CON programs have not been uniformly

successful in controlling the costs and quality of,

or improving access to, health care delivery.

Health care costs are rising at a great rate, and

some rural areas and urban public hospitals do

not have the minimal requirements for some services that are outlined in the “National Guidelines

for Health Planning” under the Federal health

planning program. This option would eliminate

the Federal requirement that States have CON

laws, but would permit those States that wanted

to continue their programs to do so.

Implementation of this option would eliminate

the State and Federal Governments’ administrative costs for the Federal program. It would also

relieve hospitals—and in some States, other facilities—of the costs of application fees, personnel, and delays involved in the CON process.

The method of treatment of capital expenditures

by the Medicare payment system will affect the

need for regulations, especially if the DRG-based

prospective payment system expands to other

payers. In the past, Medicare has reimbursed hos25-406 0 - 84 - 11
154 ● Federal Policies and the Medical Devices Industry

pitals for capital equipment on the basis of costs

(see ch. 3). Medicare’s DRG prospective payment

system provides incentives for hospitals to reduce

operating costs. If cost reimbursement for capital continues under Medicare’s DRG payment system, hospitals will face incentives to purchase

medical devices that will reduce operating costs.

If payment for capital costs is more restricted, the

incentive to purchase such devices will be weakened

(but not eliminated).

No matter how capital costs are treated, socially

desirable medical devices that raise operating costs

may not be financially desirable to hospitals.

CON programs could play a role in the proper

diffusion of socially desirable but very expensive

technologies if they could encourage particular facilities to purchase such technologies by offering

special treatment on other applications, for example. At present, this kind of negotiating role

would require changes in some CON laws.

Medicare’s DRG-based prospective payment

system itself may change the need for CON programs or for the national planning effort, especially regarding distribution of services. If the incentives of DRG payment work as anticipated,

hospitals will specialize in treating patients in

those DRGs in which they are efficient. Such

specialization will follow a hospital’s efforts to

work with its medical staff to be cost conscious

and to reduce the use of very expensive services.

Some hospitals will continue to try to attract physicians and patients through purchases of the latest

medical devices, but others will cut back some

services.

Specialization among hospitals is likely to result from the dropping of services that do not pay

for themselves through DRG payments. For example, a hospital that finds that its costs for staff,

facilities, and equipment for coronary care are

lower than the relevant DRG payment rates may

specialize in coronary care. The same hospital

may drop its pediatrics services if its costs are

higher than the relevant DRG rates. Specialization could decrease duplication of medical devices

and possibly eliminate excess capacity and lower

excess use. CON programs may become unnecessary in light of these strong cost-containment

incentives for hospitals, although the problem of

duplication of services among nonhospital settings

not covered by CON could be worsened.

If specialization decisions were made on a purely

cost basis, however, it is clear that not all services or medical devices would be available to all

segments of the population: areas of low population density or low income would suffer. The current planning process has not solved the problem

of inequitable distribution of facilities and services. Some communities and population groups

are still underserved, while certain areas have too

many hospital beds. In addition, health planning

has not thus far ameliorated the problem of public hospitals, which treat a disproportionate number of poor and elderly patients and which do not

have the funds to renovate or to purchase necessary equipment.
7.

Veterans Administration Policies

Regarding Medical Devices

War loves to play upon the young.

–Sophocles
Contents

Page

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 157

Overview of the VA Health Care System . . . . . . . . . . . . . . . . . . . . . . . . . . 157

The Veteran Patient Population . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

Veterans’ Service Organizations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

Research and Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

Rehabilitation Research and Development Service . . . . . . . . . . . . . . . . . . . . . 161

VA Prosthetics Center. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 161

Testing and Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162

Prototype Rehabilitative Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 162

Commercially Available Rehabilitative Devices . . . . . . . . . . . . . . . . . . . . . . . 163

Commercially Available Equipment and Supplies . . . . . . . . . . . . . . . . . . . . . 165

Procurement and Supply. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 166

Central Procurement by the VA Marketing Center . . . . . . . . . . . . . . . . . . . . . 166

Procurement by VA Medical Centers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168

Adoption and Use...... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

Rehabilitative Devices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 169

Influence of Social, Political, and Economic Factors . . . . . . . . . . . . . . . . . . 170

Strategic Planning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 171

Discussion and Policy Options . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Research and Development . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Testing and Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173

Procurement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 174

Adoption and Use..... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 175

TABLES

Table No, Page

38. Veterans Administration R&D Budget Overview, Fiscal Years

1977-83 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 160

39. VA Medical Center Purchasing Source Priorities, Fiscal Year 1982.. . . . . . . 169

FIGURE

Figure No. Page

4. Organization Chart of the Veterans Administration, May 1984. . . . . . . . . . . . 159
7.

Veterans Administration Policies

Regarding Medical Devices

INTRODUCTION

The Veterans Administration (VA) has a prominent role in the medical devices industry from

both the producer and purchaser sides of the market. Since the late 1940s, the VA has been an important source of research and development (R&D)

funds, notably for rehabilitative technologies. In

fiscal year 1983, the VA’s total R&D budget was

almost $160 million, of which over $10 million

was specifically earmarked for rehabilitative R&D.

Actively serving about 3 million out of 30 million veterans eligible for free health care and

rehabilitative services with an annual budget of

more than $8 billion, this agency is a significant

power in the marketplace.

The VA presents a unique example of a health

care system that includes the continuum of patients, needs, facilities, money, and personnel and

the mandate to develop, deliver, evaluate, and

support a full range of devices and services. Because of its size, the agency clearly has potential

for influencing the medical devices industry. Yet

although the VA health care system is completely

funded by the Federal Government and centrally

OVERVIEW OF THE VA HEALTH

The VA’s health care system is the largest health

care delivery organization in the Nation.2 The vast

majority of services are delivered to veterans in

VA-owned facilities. Most acute care services are

provided in 172 VA medical centers that are, for

the most part, affiliated with medical schools.

‘Unless otherwise noted, this section is adapted from a discussion in U.S. Congress, Congressional Budget Office, Veterans

Administration Health Care: Planning for 1990, Washington, DC,

February 1983 (327).

‘The Hospital Corp. of America, a private, “for-profit” hospital

chain, includes more facilities, but has revenues only about half the

size of the VA’s health care delivery budget (130).

administered, decisions regarding the purchase

and use of medical devices are primarily made at

the clinical and VA medical center levels. Overall, the impact of the VA on the medical devices

industry reflects this combination of targeted programs and policies and decentralized activities.

The relationships among the parts of the VA discussed in this chapter are depicted in figure 4.

Throughout this chapter, medical devices are

grouped and referred to in three classes:

● rehabilitative devices, such as prosthetics and

sensory aids for disabled people;

● equipment, such as radiological and laboratory equipment; and

● supplies, such as bandages and other disposable.

The discussion begins with an overview of the VA

health care system and then describes the VA’s

programs, activities, and policies with regard to

the R&D, testing and evaluation, procurement

and supply, and, finally, adoption and use of

medical devices.

CARE SYSTEM1

Begun after World War II, the affiliation program

is generally credited with enhancing the quality

of care at the VA hospitals. These hospitals operated over 82,000 beds in fiscal year 1981 and

treated about 1.25 million patients.

The VA provides both institutional and noninstitutional long-term care services. Ninety-eight

nursing homes associated with the VA medical

centers provide highly skilled extended care after

hospitalization. The VA plans to increase the

number of nursing home beds from the 8,700 beds

that were operated in 1981 to over 13,000 by 1987

to serve the rapidly expanding aged veteran pop157
158 ● Federal Policies and the Medical Devices Industry

—

ulation. Other institutional long-term care serv- nancial management policies, Twenty-eight reices are provided by the VA in community nurs- gional areas, called medical districts, control the

ing homes, where services are purchased on a per allocations that are prospectively budgeted by the

diem basis, and at State veterans’ homes, where Central Office. Each medical district is typically

the VA subsidizes care through grant programs. composed of 4 to 10 VA medical centers.

The VA also operates 15 domiciliaries, usually

on the VA medical centers’ campuses, where service-disabled or permanently disabled veterans can

live and receive necessary minimal health care.

Noninstitutional care provided includes day-care

programs for the elderly and various home-care

programs.

The outpatient programs operated by the VA

represent an alternative to hospitalization for

many veterans. In 1981, more than 15.8 million

outpatient medical visits were made to VA staff,

and 2.1 million visits were made to private physicians and funded on a fee-for-service basis by

the VA. Clinic services are varied. In addition to

diagnostic, treatment, and rehabilitative clinics,

the VA operates mental hygiene clinics and day

treatment centers for psychiatric patients and provides dental care services for long-term care patients.

In all, the VA employs the full-time equivalent

of approximately 194,000 physicians, dentists,

nurses, and administrative and support personnel. The VA’s Department of Medicine and Surgery, headed by the Chief Medical Director, administers the entire health care system with an

annual budget in 1983 of just over $8 billion. The

Department of Medicine and Surgery is administered from the VA’s Central Office in Washington, DC. Specific areas of patient care and program function (e.g., rehabilitation medicine,

surgery, radiology, and medical research) are the

responsibility of VA organizational units called

services. As shown in figure 4, these units are

under the guidance of service directors in the VA’s

Central Office.

The VA’s health care system operates under a

limited and controlled budget with plans projected

for 1 and 5 years ahead. Funding is 100 percent

Federal. Once Congress determines the overall appropriation, the budget is fixed for the following

fiscal year. However, after the appropriation level

is decided, the VA health care system is characterized by highly decentralized planning and fiThe Veteran Patient Population

Currently, there are an estimated 30 million

veterans eligible for health care services. About

40 percent of the eligible population are World

War II veterans now in their 50s or 60s. By 1990,

practically all of these 12 million World War II

veterans will be over 65 years old, and the VA

is concerned about the impact of this aging population on the health care delivery system.

Only a small proportion of the eligible population actually uses the VA health care system, however. In 1981, about 3 million veterans, or 10 percent of those eligible, used VA services. Most

veterans use community services for their health

care, presumably because they have -adequate

public or private health insurance or they prefer

the proximity of non-VA facilities. It is estimated

that only about 2 million of the World War II

veterans will apply for VA health care benefits

when they are over 65 years of age.

Any veteran with a service-connected disability

is eligible for health care services. Veterans with

service-connected disabilities represented about 34

percent of the applicants who sought medical care

from the VA in fiscal year 1982. The remainder

of the VA patients were veterans aged 65 or older

(about one-fourth of patients discharged from VA

hospitals in 1981), veterans who were unable to

pay for their medical care, former prisoners of

war, and veterans who were exposed to Agent

Orange in Vietnam. Other veterans are eligible

on a space-available basis.

Veterans’ Service Organizations

A number of veterans’ service organizations

play a significant role in the overall delivery of

health care by the VA (106). In terms of size of

membership, the major organizations are The

American Legion, the Veterans of Foreign Wars,

and the Disabled American Veterans. At the national level, these groups lobby for services and
Administration (VA),a Figure 4.–Organization Chart of the Veterans May 1984

r— -—– -7 — L..— –—..– —— -—-- — —

I 1

1 1 1

chart shows the wlat!o~ships among the parts of the V’A

bACf~D _ Assls[~t Chief Meal, cal ~lrector

CI/A ~u POIY services are located I n I ndli,ldual VA medical u?nterS

d~he prosthetic ~Whnology Evalua:,on commt!t~e advises the ?rostt]ellcs afld Sensor, Aids SerVICe

SOURCE Off Ice of Technology Assessment
160 ● Federal Policies and the Medical Devices Industry

-- —

attempt to influence legislative decisionmaking.

At the local level, they are involved in a variety

of activities including substantial support for community programs. Because of their high visibility in the community, local chapters of these orgaRESEARCH AND DEVELOPMENT

The goals and priorities of the VA’s R&D program are diverse, with broad mandates to address

the very complex and difficult problems of veterans. The official role of the Federal Government

in the R&D of medical devices, especially prosthetic and disability-related research, dates back

to the 1930s and 1940s. Since 1947, the VA has

spent over $25 million on prosthetic device research alone (225).

Research indicates that the Federal Government

can be particularly effective in sponsoring R&D

if the Government is itself the buyer of the resulting technologies (228). The VA spent well over

$1 billion on all supplies and equipment for its

various medical facilities in 1983. Especially in the

area of rehabilitative devices, not only is the VA

the major buyer in the country, but its R&D efforts are very important because of the small and

fragmented nature of the market for many rehabilitative technologies.

Table 38 shows the VA budget for R&D activities, as divided among the VA’s three major R&D

services: the Medical Research, the Rehabilitation

Research and Development, and the Health Services Research and Development Services. Although

funds committed to these R&D services by the VA

in current dollars have increased over the past few

years, the budgets of these services have been

nizations can have an important influence on VA

hospital activities. Hospital administrators are

sensitive to their inquiries and complaints and usually try to consult these organizations when major planning decisions are under consideration.

stable or declining if inflation is taken into account. Furthermore, total R&D as a proportion

of medical care expenditures by the VA has been

steadily declining for a decade. In fiscal year 1970,

R&D budgets accounted for 3.4 percent of the

outlay for the medical care program, compared

with only 2 percent in fiscal year 1982 (433).

Veterans’ service organizations have expressed

concern about effective cutbacks in R&D budgets,

especially in the areas of prosthetics research and

research on sensory aids for blind and hearingimpaired veterans. The organizations argue that

these research areas have received decidedly less

funding than they merit (344).

The bulk of R&D funds goes to the Medical Research Service, which provides opportunities for

clinician and nonclinician scientists to study health

problems in the veteran population. The emphasis of the medical research is on clinical research,

most of which is initiated by physician investigators who carry out their research part-time and

spend the majority of their time treating veteran

patients. Current studies involve cardiovascular,

respiratory, and renal devices. A number of research projects are also conducted cooperatively,

with clinical trials at multiple sites within the VA

medical care system. The largest number of cooperative studies have tested drug therapies, folTable 38.—Veterans Administration (VA) R&D Budget Overview, Fiscal Years 1977-83 (thousands of dollars)

Fiscal year

1977 1978 1979 1980 1981 1982 1983

Medical Research Service . . . . . . . . . . . $101,567 $108,153 $118,016 $122,745 $129,943 $130,842 $141,052

Staffing . . . . . . . . . . . . . . . . . . . . . . . . . . 4,220 4,367 4,217 4,171 4,171 3,845 4,015

Rehabilitation R&D Service . . . . . . . . . . . 4,419 5,502 7,191 8,085 8,784 7,185 10,001

Staffing . . . . . . . . . . . . . . . . . . . . . . . . . . 69 90 112 143 -143 128 250

Health Services R&D Service . . . . . . . . . 3,604 2,996 3,004 3,153 3,083 2,828 3,786

Staffing . . . . . . . . . . . . . . . . . . . . . . . . . . 45 90 105 104 104 93 120

Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . $113,924 $121,198 $132,645 $138,401 $145,942 $144,921 $159,224

SOURCE: U.S. Veterans Administration, 1983.
Ch. 7—Veterans Administration Policies Regarding Medical Devices . 161

—. — .-—

lowed by surgical procedures, such as coronary

artery bypass surgery (342).

The Health Services Research and Development

Service, which was organized in 1976, develops

and supports programs designed to improve clinical and administrative decisionmaking in the VA

medical care system. Its only research priority

area that concerns medical devices is the assessment of the cost effectiveness of patient care technologies. The third VA service, the Rehabilitation

R&D Service, is substantially involved with research and medical devices, as described in the

following section.

Rehabilitation Research and

Development Service

The Rehabilitation R&D Service is the result of

an increased focus, both at the VA and at the national level, on rehabilitation research and engineering needs. In 1973, this program was separated from other R&D efforts at the VA and given

a mandate to improve the quality of life and to

facilitate greater independence for physically

disabled veterans.

The Rehabilitation R&D Service undertakes research, development, and evaluation of new rehabilitative devices and techniques. The main goal

of the program, which is primarily oriented to sophisticated equipment, is to develop “usable”

devices that assist individuals. All activities are

coordinated with the National Institute of Handicapped Research at the Department of Education.

The Rehabilitation R&D Service is also concerned

with technology transfer, including increasing the

availability of new devices on the market (352).

The activities of the Rehabilitation R&D Service are concentrated in three areas—prosthetics,

spinal cord injuries, and sensory aids, representing the most prevalent service-connected disabilities of veterans. Prosthetics research makes up

about 40 percent of the Rehabilitation R&D Service budget; research relating to spinal cord injuries, with an emphasis on improving wheelchairs, makes up about 30 percent of the budget;

and research on sensory aids, which include aids

for visually and hearing-impaired people and for

communication disorders, makes up the remaining 30 percent (426). Research priorities within

these areas are identified through a combination

of internal review and workshops and seminars,

which include representatives from provider and

research groups, manufacturers, and disabled

veterans’ organizations.

The Rehabilitation R&D Service supports both

intramural and extramural R&D programs, although over the past few years, funding has shifted

away from extramural projects and toward intramural projects such as VA-established centers

and their university-affiliated programs. Two

rehabilitation R&D centers, tied directly to the VA

Rehabilitation R&D Service, have recently been

established: one in the Palo Alto VA Medical Center in California and the other in the Hines VA

Medical Center in Illinois outside of Chicago. Six

more such centers are planned by 1986.

The rehabilitation R&D centers are affiliated

with leading engineering schools in the same way

that the VA medical centers are affiliated with

medical schools. These affiliations bring faculty

and students into clinical research settings to study

the problems of disabled people and to investigate

new procedures and devices to alleviate their

problems. The rehabilitation R&D centers’ primary goal is to apply advanced technology, such

as microprocessors, to assist physically handicapped veterans.

In an approach similar to the rehabilitation

R&D center concept, the Rehabilitation R&D

Service is establishing university-affiliated research

engineering programs to help support qualified

engineering graduate students and faculty who

undertake rehabilitation engineering projects. The

thrust of the program is to interest engineering

students in rehabilitation engineering and to create

a flow of ideas and information between academia

and the VA (69,125).

VA Prosthetics Center3

The VA Prosthetics Center is a VA R&D center in New York City that is within the Prosthetic

3

Since its inception in 1956, the VA Prosthetics Center has also

been known as the VA Rehabilitation Engineering Center (VAREC)

and as the Prosthetic Evaluation Testing and Information Center

(l’ ETIC)
162 • Federal Policies and the Medical Devices Industry

and Sensory Aids Service (see fig. 4). The VA

Prosthetics Center was established in 1956 to conduct R&D in rehabilitation engineering, to evaluate and test commercially available rehabilitative

devices, to provide direct patient care for difficult prosthetic and orthotic cases, and to manufacture orthopedic footwear and prosthetic/orthotic devices.

In its earlier years, the VA Prosthetics Center

was the “flagship” of a successful VA intramural

research program in prosthetics and orthotics. The

majority of the prosthetic limbs and the fitting

techniques used today, for example, were developed by the VA Prosthetics Center in the 1950s

(431). However, a 1983 audit report by the VA’s

Office of Inspector General found management

and operating problems at the VA Prosthetics

Center, then known as the VA Rehabilitation

Engineering Center (VAREC) (426). The report

recommended changes in VAREC’s organization,

including discontinuation of the R&D program.

TESTING AND EVALUATION

Literally thousands of disability-related devices

are being produced by the public, private, and

nonprofit sectors. Although many are relatively

simple and low-cost items, others are expensive

and complex. Regardless of the devices’ cost, use,

or complexity, certain criteria need to be met

before these products enter widespread use. Safety

and effectiveness, including durability and recommended applications, are the essential criteria that

need to be evaluated (412).

Currently, the responsibility for testing and

evaluating medical devices is divided among several VA organizational units. Prototype rehabilitative devices that are still in the developmental

stage are evaluated by the Rehabilitation R&D

Service. Once medical devices are commercially

available, the responsibility for evaluation is split

between: 1) the Prosthetic and Sensory Aids Service, which evaluates rehabilitative devices; and

2) the Office of Procurement and Supply, which

evaluates all nonrehabilitative devices, equipment,

and systems purchased by the VA.

The VA’s Department of Medicine and Surgery

accepted the Inspector General’s recommendation,

disbanded the VAREC Research and Development

Service in fiscal year 1984, and changed the organization’s name to the Prosthetic Evaluation Testing and Information Center (PETIC) (430).

The VA Prosthetics Center encouraged innovation in the past by demonstrating that new types

of wheelchairs were technologically possible and

safe, and, most importantly, that there was a

substantial market for them—the VA (282). The

Prosthetics Center’s work with power wheelchairs

in the early 1970s demonstrated that electric

wheelchairs could be used safely at speeds greater

than a slow walk and that they could be designed

to be used on rough terrain. This situation encouraged wheelchair manufacturers to begin making chairs with those capabilities. Efforts centered

around lightweight sports wheelchairs had a similar effect on manufacturers.

Prototype Rehabilitative Devices

Rehabilitative devices developed by the VA

often do not complete the transition from research

prototypes to commercially viable products. The

VA’s research funds have supported a number of

expensive prototypes that have been neither put

into general use for the veteran population nor

discarded outright. Examples include a wheelchair

with special electronic controls adapted for use

in a vehicle, a four-bar linkage knee for use in

above-knee prostheses, and a standing device for

paraplegics (433).

Although there are several reasons for the failure of such prototypes to become viable products,

one obstacle is the lack of unbiased evaluations

of the prototypes that provide data on performance and clinical applications. The inadequacy of

internal testing and evaluation for prototype

rehabilitative devices has been generally recognized by the VA. Although some VA facilities,

including the rehabilitation R&D centers, the VA

Prosthetics Center, and individual VA medical
Ch. 7—Veterans Administration Policies Regarding Medical Devices ● 163

centers, have been involved in testing new and

emerging devices through various VA services,

the Rehabilitation R&D budget has not provided

adequate funds to purchase expensive prototypes

for clinical evaluation (433). Moreover, the VA

has had a general procurement policy of not purchasing equipment unless it is commercially available and in clinical use (344).

There have also been concerns about unnecessary duplication in rehabilitative device evaluation when the Rehabilitation R&D Service has

conducted testing. For example, special recreational ski equipment for disabled people, which

was developed and tested at the Palo Alto Rehabilitation R&D Center and then further tested at

four independent centers, could not be purchased

for veterans until the equipment had gone through

an essentially duplicative testing process at the VA

Prosthetics Center (19,196).

In response to these criticisms, the Rehabilitation R&D Service has recently established the

Rehabilitation Research and Development Evaluation Unit, a coordinating group to conduct clinical evaluations of new devices, techniques, and

concepts in rehabilitation and to promote commercialization of the prototype devices that are

evaluated by the program. The new unit will be

responsible for developing evaluation protocols

and will generally oversee and coordinate the

evaluation process. However, all the organizational units within the VA that have a stake in

the devices’ development and ultimate commercial success will share in funding the major evaluations (435).

Although it is premature to assess the Rehabilitation R&D Evaluation Unit at this time, the unit

appears to have the potential of coordinating

work so that evaluations are perceived as valid

by organizational units of the VA that use the results and duplication of effort is avoided.

In an attempt to further structure its technology transfer efforts, the Rehabilitation R&D Service has recently entered into an interagency agreement with the U.S. Department of Commerce to

identify and develop potential markets and financing for prototype devices that were funded and

developed by projects of the Rehabilitation R&D

Service. The goal of the interagency program is

to develop a process that leads to the commercialization of VA devices and technology.

Commercially Available Rehabilitative

Devices

Once rehabilitative devices are commercially

available, the responsibility for their evaluation

shifts from the Rehabilitation R&D Service to the

VA’s primary user service, the Prosthetic and Sensory Aids Service. Throughout the 1970s, the

Prosthetic and Sensory Aids Service increasingly

employed performance standards in its prosthetic

and sensory aids program. These standards are

developed with the participation of individuals

and organizations both within and outside the

VA. Manufacturers, professionals, VA supply

specialists, and others review the standards, which

provide product specifications to control devices’

quality, safety, and performance.

After a performance standard for a rehabilitative device has been established, the VA Prosthetics Center tests the device for compliance with

the standard and determines whether or not products meet the VA’s requirements. As noted earlier,

the VA Prosthetics Center has recently become

the VA’s organizational focus for evaluation of

commercially available rehabilitative devices.

The testing protocols used by the VA Prosthetics Center range from simple validation assessments to complex clinical evaluations involving

dozens of VA medical centers or clinics. At the

least, rehabilitative devices are tested for safety,

reliability, and the validity of manufacturers’

claims.

Devices can undergo either special laboratory

testing or “field testing” at VA medical centers.

Field testing, although advantageous in that it

assesses devices’ “usefulness,” has never been utilized extensively by the VA Prosthetics Center because of organizational difficulties. Until fiscal

year 1984, no line authority existed from the VA

Prosthetics Center staff or from the Prosthetic and

Sensory Aids Service to the medical centers. The

absence of line authority has typically resulted in

loss of control over adherence to protocols and

lack of reliable reporting of evaluation data (465).
164 . Federal Policies and the Medical Devices Industry

The VA evaluation process for commercially

available rehabilitative devices has increasingly

been the target of complaints, particularly from

veterans’ groups. The Disabled American Veterans has characterized the evaluation system as

being “fraught with inefficiencies and communication breakdowns” (439). There has also been

criticism on several other fronts: that testing

priorities are not adequately established; that long

lags exist in the evaluation process; that the needs

of veterans for devices should be better anticipated; that the devices should be evaluated for

safety by the Food and Drug Administration instead of by the VA; and that the VA should test

for efficacy and cost effectiveness.

The standard-setting process has also been a

cause of concern for veterans’ organizations and

others. Critics claim that the VA specifications

have often been written to the specifications of

a particular manufacturer’s product, putting other

manufacturers at a distinct disadvantage in the

VA market. If such specifications define the dimensions and materials to be used in devices, it

is more difficult for emerging devices that are different in design or performance levels to enter the

general marketplace (352).

Shepard and Karen, who studied the VA’s effects on the wheelchair industry, concluded that

the large population of users in the VA could afford an opportunity for the VA to expand its role

in postmarketing surveillance of wheelchairs (252).

Such surveillance could yield better data on the

frequency of repairs and the advantages and disadvantages of particular models during actual use.

VA standards in the past had apparently been tied

to the design of a particular wheelchair (manufactured by Everest and Jennings) rather than

based on performance. The need for performancebased standards in the future has been recognized,

and the VA has taken steps to produce such standards. VA standards are important to the industry, as evidenced by responses to Shepard and

Karen’s telephone survey. One manufacturer

stated that it hesitates to make anything that it

cannot sell to the VA; other manufacturers stated

that VA standards are considered when they make

R&D decisions (282).

The VA exercises its greatest market power in

the “depot” wheelchair, an inexpensive generalpurpose manual wheelchair. On the one hand, the

VA’s large purchases of this model reduce its price

to the VA. On the other hand, the VA tends to

discourage ordering of chairs with more user

features or better technology. If alternative models

were also stocked, price advantages could still be

obtained (although possibly not so good as the

present ones) and more desirable features, such

as lighter weight, could be offered to disabled

veterans (281).

Over the past 2 to 3 years, the VA procurement

process has replaced most standards and device

specifications with more general purchase descriptions—commercial item descriptions (CIDs)—

that are designed to accommodate the variety of

privately developed and marketed devices (32).

CIDs are simplified product descriptions that identify by functional or performance characteristics

the available, acceptable commercial products for

Government use.

Currently, the VA has standards for only four

or five rehabilitative devices, though these standards are applied to a wide range of devices. For

example, the standard for wheelchair lift systems

covers 21 different models and 13 different manufacturers. The increased use of CIDs, however,

has also been criticized. A 1982 study by the U.S.

General Accounting Office concluded that the

CIDs contained too little specific information,

with the result that the VA was purchasing many

medical items that were either unnecessary or of

lower quality (332).

To address these concerns, the Prosthetic and

Sensory Aids Service initiated the Prosthetic Technology Evaluation Committee in 1982. This committee has developed an evaluation and coordination process for rehabilitative devices that will

soon be operational in the VA system.

The Prosthetic Technology Evaluation Committee’s strengths lie in two areas. First, the committee will coordinate evaluation activities with

all the concerned participants inside the VA system, as well as with other Federal agencies, independent testing labs, and veterans’ organizations.

Representatives from the VA’s Prosthetic and Sensory Aids Service, Office of Procurement and

Supply, Inspector General’s Office, Rehabilitation

R&D Service, Rehabilitation Medicine Service,
Ch. 7—Veterans Administration Policies Regarding Medical Devices ● 165

and from the Paralyzed Veterans of America and

the Disabled American Veterans are permanent

members of the Prosthetic Technology Evaluation

Committee. Second, the committee will classify

devices into three product levels according to potential level of risk, innovation, and cost, and the

classification will determine the types of evaluations that the devices will undergo.

The Prosthetic Technology Evaluation Committee has enlisted the support of important consumer groups such as the Paralyzed Veterans of

America and The American Legion, and it appears

to be taking the necessary steps toward a more

coherent and well-focused program of evaluation

(245,288). But the committee still has some problems to resolve—such as expanding the VA Prosthetics Center’s field-testing activities, making

evaluations more national in scope, and establishing the committee’s authority over the evaluation

activities of the VA medical centers.

Commercially Available Equipment

and Supplies

At any given time, at least 250 nonrehabilitative

devices, ranging from hospital-based equipment

to supplies and disposable, are being reviewed

by the VA’s Office of Procurement and Supply

as a prerequisite to procurement contracts. Its

Testing and Evaluation Staff, which was established in 1976 and is part of a larger marketing

center and supply depot in Hines, Illinois, has primary responsibility for this aspect of the VA’s device-testing activities.

The Testing and Evaluation Staff, with fewer

than a half-dozen professionals, also has responsibility for a market research and analysis program. The staff identifies specific medical devices

for evaluations through requests by VA medical

centers, manufacturers, and the VA Central Office, as well as through in-house initiatives. Factors such as volume and interest expressed by VA

health care facilities are usually more important

than the cost of the products (238).

Thus, evaluations of nonrehabilitative equipment and supplies are primarily carried out on

standard stock items and smaller medical equipment. Very expensive equipment, such as computed tomography (CT) scanners, is not evaluated

by the Testing and Evaluation Staff; the service

directors in the VA’s Central Office are responsible for approving or disapproving the acquisition

of such “controlled items. ” These central purchase

decisions are based on either test data generated

by manufacturers, local medical equipment committees in individual medical centers, or, in a few

instances, interdisciplinary advisory committees

convened by the Central Office.

The Testing and Evaluation Staff’s evaluations

are usually internal “consumer research” efforts

aimed at validating manufacturers’ claims about

their products. VA regulations prohibit explicit

comparison of one product with another. Although some evaluations of classes of devices have

been attempted—evaluations that begin to move

toward analyses of relative efficacy or cost-effectiveness—staffing and budget constraints have

restricted the number of these efforts (238).

Typically, tests on individual devices are carried out at VA medical centers around the country and take the form of user surveys. The results

are synthesized into very short summaries and

published quarterly by the VA Office of Procurement and Supply. The Testing and Evaluation

Staff also manages a computerized information

system with price and marketing data on medical devices.

The results of evaluations of nonrehabilitative

equipment and supplies by the Testing and Evaluation Staff are well disseminated to users within

the VA health care system. Although the Office

of Procurement and Supply is sometimes reluctant to publish the test results because the particular needs of veterans may be different from

the needs of the general population, such information is routinely requested by non-VA hospitals, nursing homes, and State and local governments. Manufacturers are not permitted to use the

VA’s evaluations in their own literature, but private publications such as Consumer Reports, Hospital Purchasing Management, and Health Devices

Alert often reprint survey results (68,238,434),

The Testing and Evaluation Staff’s evaluations

are advisory in nature. Although not scientifically

rigorous, these evaluations do provide an information base for purchasing by individual VA fa-
166 • Federal Policies and the Medical Devices Industry —

cilities. The Testing and Evaluation Staff’s evaluations are, by all accounts, most often used by

smaller, more rural VA facilities. The VA estiPROCUREMENT AND SUPPLY

The VA Office of Procurement and Supply is

responsible for supplying the most extensive medical program in the Federal Government. In fiscal

year 1982, the VA spent nearly $1.3 billion on

supplies and equipment for its various medical facilities. Totaling nearly 6,800 employees, the procurement and supply effort includes staff at the

VA Marketing Center (VAMKC), the VA’s Central Office, three supply depots, the Prosthetic

Distribution Center, and 172 individual medical

centers. Procurement staff have the twin goals of

purchasing devices at the lowest possible cost and

assuring the delivery of quality supplies and

equipment for veterans. Efforts are divided between central procurement activities and the local

supply activities of the VA medical centers.

Central Procurement by the

VA Marketing Center

VAMKC in Hines, Illinois, is the focus of the

VA’s national purchasing activity. That VAMKC

has acted as the contract negotiator and administrator for the U.S. Public Health Service, the

armed services, and other Government agencies

as well as for the VA has greatly enhanced its market leverage. In July 1983, VAMKC’s shared procurement program with the Department of Defense, for example, was awarding annual

contracts of $295 million (428). Overall, VAMKC

procurement accounts for a substantial, but not

dominant, proportion of national demand for

medical equipment and supplies. Bradburd found

that VAMKC procurement accounted for 5 to 10

percent of the national sales volume in the markets for X-ray, nuclear diagnostic, hemodialysis,

and patient monitoring equipment (344).

The market power of the VA allows it to obtain favorable prices on medical supplies through

its centralized procurement channels (167). Volume purchases of medical supplies and equipment

are managed and distributed through three VA

mates that only about 20 percent of its medical

centers strictly adhere to purchasing decisions

based on the evaluations.

supply depots located in Somerville, New Jersey;

Hines, Illinois; and Bell, California. The Prosthetic

Distribution Center in Denver, Colorado, serves

the approximately 200,000 veterans with service-connected disabilities. In fiscal year 1982, VA

medical centers obtained about $198 million in

supplies (about 15 percent of their total procurement needs) from the central supply depots (428).

Several other centralized procurement programs

provide individual medical centers with opportunities to obtain economically priced supplies and

equipment without having to solicit and award

contracts. Under the Federal Supply Schedules

program, the Government contracts with commercial vendors for a wide range of supplies and

services at preestablished prices. VAMKC manages Federal Supply Schedules’ contracts for medical drugs, chemicals, supplies, and equipment,

while the General Services Administration manages the contracts for most other items, such as

furniture and office supplies (335). About 34 percent of total purchases by VA medical centers,

or $434 million, were made through the Federal

Supply Schedules program in fiscal year 1982

(428).

Decentralized contracts are similar to the Federal Supply Schedules program, in that medical

centers order from VAMKC-administered contracts. Usually these contracts, which account for

only about 3 percent of total purchases by medical centers, are for specialized medical equipment

that is unavailable through either the supply depot or Federal Supply Schedules programs.

The impact of VAMKC’s centralized procurement policies and procedures on product prices

was studied by Bradburd specifically for this OTA

report (42). The study examined VA procurement

of nine categories of major medical equipment.

Although the market was found to be highly concentrated, the volatility of market shares and the
Ch. 7—Veterans Administration Policies Regarding Medical Devices • 167

very rapid pace of technological change suggested

that the market was also extremely competitive.

Bradburd’s findings with regard to six VAMKC

procedures or policies are presented below (42).

Brand Name Justification

When a VA hospital receives authorization to

purchase a particular item of equipment, VAMKC

forwards to the hospital a list of the suppliers on

contract whose equipment meets the requirements

of the purchase order, ranked by order of cost.

The hospital is required to purchase from the leastcost supplier unless it can justify purchasing from

a different source based on service availability or

another acceptable consideration. This exception

process is called a brand name justification. Because suppliers are anxious to maintain their share

of the VAMKC market, the brand name justification requirement puts them under pressure not to

price themselves out of the VAMKC market, and

this concern almost certainly results in lower

prices than would be obtained in the absence of

this requirement.

Firm Fixed-Price Clause

Under the terms of a VAMKC contract, suppliers are not allowed to increase prices during

the contract year. Furthermore, if they lower the

price at any time during the year, the lower price

holds for the balance of the contract year. The

firm fixed-price clause may or may not result in

lower procurement costs. During the course of the

business year, there are times when suppliers offer temporary price discounts in the private market to promote their products. Normally, it would

be expected that these promotions would be extended to VAMKC as well. However, because a

temporary price cut must be extended for the entire contract year, suppliers are reluctant to offer

such discount prices to VAMKC.

Even the requirement that prices cannot be increased during the course of a contract year has

indeterminate effects on procurement costs. On

the one hand, such a requirement protects those

who buy through VAMKC from price increases

for the contract year. On the other hand, it is possible that suppliers charge a higher price to begin

with as a form of insurance against their margins’

being eroded by cost increases. It is not possible

to determine the direction of the total impact of

the firm fixed-price clause.

Public Disclosure Requirements

By law, the public has access to the prices at

which VAMKC procures medical equipment.

There is both theoretical and empirical support

for the view that this results in higher procurement costs for VAMKC. The reasoning is that the

benefits that a firm receives from cutting its price

below that of its rivals are in part a function of

the “retaliation lag, ”the length of time before

rivals learn of the price cut and cut their own

prices in response. The price disclosure requirements have the effect of reducing the retaliation

lag, and therefore act to discourage such price cutting in the VAMKC market.

In addition, because private buyers of medical

equipment also have access to the price data, the

fact that the VAMKC price may serve as the

buyer’s target in pricing negotiations can also inhibit price cutting in the VAMKC market. Suppliers in the market for X-ray equipment, nuclear

medical equipment, patient monitoring, and hemodialysis equipment indicate that prices offered to

VAMKC are higher than they would be in the

absence of the contract disclosure requirement.

In markets where the disclosure requirement has

not affected pricing, the perceived reason is that

pricing information is widely available from other

sources.

No Volume Commitment

VAMKC does not make specific volume commitments to its suppliers, who contract to provide equipment at preestablished prices. In most

equipment categories (other than X-ray and nuclear diagnostic equipment), the absence of a volume commitment is a major factor in supplier

pricing behavior.

There are several reasons why a volume commitment appears to be very important in some

industries and unimportant in others. First, the

importance of a volume commitment seems to depend on whether the equipment is typically “custom made” or purchased from supplier stock. If

equipment is purchased from stock and is fairly
168 ● Federal Policies and the Medical Devices Industry

—

homogeneous, a volume commitment can provide

reductions in manufacturing cost that can be

passed on to the buyer in lower prices.

Second, the importance of a volume commitment seems to depend on whether the equipment

is expensive or inexpensive. If the equipment is

inexpensive, the costs of preparing contracts and

marketing the product to buyers are higher relative to the purchase price of the equipment. In

this situation, the cost savings that come with a

volume commitment are more significant, and the

commitment allows some of these savings to be

passed onto the buyer. Some suppliers indicated

a willingness to lower prices by 5 to 10 percent

in exchange for a volume commitment. Even for

relatively expensive devices, such as ultrasound

equipment, one supplier stated that a group purchase of 15 to 20 units would suffice for a larger

price discount than now offered.

Most Favored Customer Clause

Under the terms of a VAMKC contract, suppliers are not allowed to sell their equipment under

a similar contract to any private buyer at a price

lower than that offered to VAMKC. If a lower

price is offered to a private buyer, the vendor

must lower the VAMKC contract price to the

same level for the balance of the contract. Because

VAMKC must be offered a price as low as that

offered to any private buyer, the most favored

customer clause helps ensure that the VAMKC’s

clients benefit from competition among suppliers

in the private hospital market.4

Although the strictness with which the most

favored customer clause is interpreted varies from

one equipment category to another, it almost certainly has the effect of reducing VAMKC equipment procurement costs. The policy can also have

a powerful impact on private buyers. In a few

markets, private buyers are offered lower prices

than VAMKC when they make contractual volume commitments, on the grounds that the contracts are not like the VAMKC contract. In these

markets, the impact of the most favored customer

policy is obviously less than it is in other markets.

4As noted above, VA suppliers may offer lower prices to private

buyers if contract terms, such as volume commitments, differ.

However, in many cases the most favored customer clause may have the effect of increasing

prices that private buyers must pay for medical

equipment. Specifically, both buyers in the VA

and suppliers indicated that prices were affected

in the markets for X-ray, nuclear diagnostic,

ultrasonic, and patient monitoring equipment, as

well as for CT scanning devices.

Reluctance To Procure Mixed Systems

Despite the absence of a formal restriction,

VAMKC has exhibited a reluctance to purchase

medical equipment systems in which items of

equipment produced by several different companies are interconnected. There are several reasons for this, the most important of which are the

difficulties of assigning financial responsibility for

repair-s under warranty and of determining responsibility for the actual interconnection of the

equipment. Unfortunately, VAMKC’s policy can

have the effect of practically eliminating many

smaller companies from the procurement process, and may, as a result, cause higher initial procurement costs for the VA. The reluctance to

purchase mixed systems is based on actual procurement experience, but the practice merits periodic review to determine if it saves costs over

time.

Procurement by VA Medical Centers

Actual purchase of medical equipment and supplies is carried out by local supply officers located

in each of the VA medical centers. Although

VAMKC is responsible for centrally managing

and negotiating contracts for items commonly

used by the medical facilities, individual VA medical centers make their own purchase decisions.

To the extent that the medical centers use the centrally managed supply channels, lower product

costs are available to them through the combined

VA-wide quantity purchases. However, the VA

hospital system is actually a loose confederation

of semiautonomous institutions in terms of device

procurement, thereby reducing many of the advantages available to it as a large market power.

Increasingly, the VA medical centers have purchased their supplies and equipment on the open

market rather than using central supply channels.
Ch. 7—Veterans Administration Policies Regarding Medical Devices ● 169

Whereas in the early 1960s, only about 10 percent of their medical supplies were acquired

through local-level open market purchases, in fiscal year 1982, 39 percent of total purchases were

made on the open market (131,428). Table 39

shows the relative contribution of each of the VA’s

supply channels to the total purchases made by

the VA medical centers. The increase in open market purchases has resulted primarily from an implicit policy within the VA system to allow individual physicians the freedom to choose their own

medical equipment and supplies.

Both a 1980 General Accounting Office report

(335) and the recent report by the President’s Private Sector Survey on Cost Control (Grace Commission) (131) concluded that the VA was unnecessarily paying more for supplies and equipment

because of the large percentage of purchases being made on the open market. Finding that the

VA defeats the price advantages available to it

through greater item standardization and volume

purchases, the reports called for greater central

purchasing through an expansion of national contracts.

Table 39.—Veterans Administration Medical Center Purchasing Source

Priorities, Fiscal Year 1982

Approximate

Veterans annual

Administration purchases Percentage

Supply channel priority ranking ($ in millions) of total

Veterans Administration excess . . . . . . . . .

Veterans Administration supply depots . . .

Other Government excess . . . . . . . . . . .

Federal prisons and correctional

institutions, blind-made and severely

handicapped products . . . . . . . . . . . . .

General Services Administration

stock . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

Veterans Administration decentralized

contracts . . . . . . . . . . . . .

Federal Supply Service contracts . . . . . . . . .

Open market purchases . . . . . . . . . . . .

Other . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

1

2

3

4

5

6

7

8

none

$197.9

0.4

1.0

34.1

41.4

434,4

498.2

86.0

NA

15.30/0

1

2.7

3.2

33.6

38.5

6.6

NA indicates information not available.

SOURCE: U.S. Veterans Administration, 1983.

ADOPTION AND USE

Rehabilitative Devices

Unlike coverage policies under Medicare and

Medicaid (see ch. 3), the VA’s policy is to make

available all rehabilitative technologies and devices that are suited to the needs of millions of

eligible veterans. Of course, determinations about

circumstances and clinical needs still need to be

made, but VA policy is to provide blind veterans

with the necessary services and devices to overcome their disability and to provide disabled

veterans with all technologies and devices deemed

medically necessary. An issue of mounting concern to the VA users and policymakers is the cost

of this policy of covering all available technologies and devices (352).

25-406 0 - 84 - 12

The range of rehabilitative medical devices provided by the VA health care system is enormous.

There are, for example, over 300 types of sensory

aids provided for blind people (39). In fiscal year

1982, about 34,000 hearing aids and over $80 million in prosthetic services were made available to

eligible veterans (426). In the area of rehabilitation services, more than 80 percent of eligible

veterans have non-service-connected disabilities,

with a large proportion suffering from the effects

of chronic diseases associated with aging.

Determinations of individual veterans’ needs

are made at the clinical level, within the patientphysician relationship. Usually, the health professional caring for the patient requests procure-
170 ● Federal Policies and the Medical Devices Industry

— —

ment of needed medical devices through the VA

Supply Service in an individual VA medical center. However, procurement of prosthetic devices

is handled differently. All prostheses, from eyeglasses to motorized wheelchairs, are obtained

through the prosthetic representative, a veteran

with a service-connected disability hired by the

VA to serve as the purchasing agent.

Clinical teams of physicians, physical/occupational therapists, prosthetists, and prosthetic representatives meet with the veteran to decide which

Photo credit: Amigo Sales, Inc.

This woman is using an Amigo power wheelchair. For

the provision of power, as opposed to manually

operated, wheelchairs to veterans, the VA requires

the approval of an individual VA medical center.

prostheses should be prescribed. They then choose

from among the possible range of devices that

have been approved by the Prosthetic and Sensory Aids Service.

Because of the relatively high volume of devices

handled by the Prosthetic and Sensory Aids Service, the other VA rehabilitative services, such as

the Spinal Cord Injury Service, have come over

the years to use that service as a central purchasing clearinghouse for their own supplies and devices. This situation has involved the Prosthetic

and Sensory Aids Service in ordering devices such

as pacemakers that have very little to do with the

actual functions of the prosthetic representatives.

Although this manner of handling supply procurement has helped hold down the personnel requirements of the other services, it has also placed increased fiscal and administrative burdens on the

Prosthetic and Sensory Aids Service (93,439).

The budget of the Prosthetic and Sensory Aids

Service has tripled in 8 years to $84 million, and

it has been projected to reach $500 million annually in 4 to 5 years (93). One of the major reasons for the steep rise in costs has been the increasing purchase of the sophisticated technology

that is now available for use by disabled veterans.

Another reason has been the growing population

of veterans whose mobility and senses are affected

by the aging process (426). Probably the most important reason for the budget increases, however,

is that, by law, the provision of prosthetics to

veterans is unlimited, The growth in these costs

has in turn taken resources from other parts of

VA health care,

Influence of Social, Political, and

Economic Factors

Political and social forces greatly influence the

adoption and use of medical devices within the

VA health care system. As mentioned earlier, for

example, veterans’ service organizations frequently

approach their local VA hospital administrators

about buying the latest technologies for their veteran constituencies. As another example, Thompson has argued that decisions about VA hospital

construction depend more on access to medical

school skills and resources than on other concerns,
Ch. 7—Veterans Administration Policies Regarding Medical Devices ● 171

such as promoting access of veterans to medical

care (298).

The VA medical centers have tried to make

their institutions hospitable places for teaching

and research. In this regard, medical schools have

often successfully encouraged VA hospitals to seek

the latest in equipment and specialized facilities.

A study by the National Academy of Sciences

noted marked proliferation of special care units

in VA hospitals by the end of the 1970s (224).

Health planning and utilization review agencies (see ch. 6) have no authority over VA medical centers. The National Health Planning and

Resources Development Act of 1974 (Public Law

93-641) gave the VA voting membership on State

health coordinating councils and on local health

systems agencies, but VA medical centers submit

applications for new construction or equipment

to the local health planning agencies on a strictly

voluntary basis. Likewise, the VA has successfully

resisted efforts to place its hospitals under the

authority of utilization and quality control peer

review organizations, which perform utilization

reviews for the Medicare and Medicaid programs.

Instead, the VA moved to establish its own Health

Services Review Organization to foster quality

assessment and utilization review.

Political and economic forces have acted to constrain the adoption and use of medical devices.

The VA’s overall health care budget has been

stable during the past few years, and the tight

budget has undoubtedly served as the most powerful rein on overadoption. In addition, the congressional appropriations committees and other

oversight groups have frequently opposed the

VA’s autonomy in decisionmaking with regard to

resource allocation. In 1978, for example, efforts

by the VA to supplement 24 existing CT scanners

with 13 additional scanners were criticized by the

General Accounting Office, and congressional resistance eventually prompted the VA to withdraw

the request (330). As another example, the Office of Management and Budget successfully pressured the VA to reduce its supply of hospital beds

from roughly 121,000 in 1964 to fewer than 90,000

by 1980 (298).

Overall, the concurrent social and political

pressures that develop incentives to overadopt

devices in some areas, while constraining expenditures in others, have had important implications

over time. The often sporadic patterns of adoption and use of devices and other technologies and

patterns of care by the VA have led to a distribution of resources that may not be equitable or efficient across geographic areas or types of facilities. Thus, for example, although the VA is an

international leader in such areas as cardiac care

and radioisotopes, fewer than one-third of the VA

medical centers had CT scanners in 1983 (150).

In fact, an extensive study by the National Academy of Sciences in 1977 found ample evidence of

maldistribution in terms of equipment, basic and

specialized services, staffing, and number of beds

(224).

Strategic Planning

There is every indication that with regard to

medical device and technology acquisition, the

VA is in transition. Perhaps the most significant

initiative undertaken by the agency in relation to

medical equipment adoption and use has been the

implementation since fiscal year 1981 of Medical

District Initiated Program Planning (MEDIPP).

The MEDIPP process is an attempt to create a decentralized long-range “strategic planning system”

in which major plan development responsibilities

are assigned to the VA’s 28 medical districts.

The VA has recognized that past resource-based

planning and management approaches are no

longer feasible in an era of stable or declining

health care budgets and changing demands by its

aging veteran population. Although there will be

increased demand for services in the short term

as the size of the elderly veteran population grows,

in the long-term, demand for services will decline

as this largest group of beneficiaries now entering old age dies.

Because the future certainly holds cutbacks or

termination of specific services or facilities, understanding and acceptance within the VA and

its constituencies are important factors in the eventual success and implementation of the MEDIPP

process. A key element of the new planning process is its emphasis on involving administrative and

clinical personnel at several levels within the VA

Department of Medicine and Surgery (429).
172 ● Federal Policies and the Medical Devices Industry

The MEDIPP process consists of a cycle of

events throughout the fiscal year. It begins with

direction by the VA’s Chief Medical Director on

broad-based issues, objectives, and goals for the

future. Each VA medical district then appoints a

District Planning Board and staff to develop a

district plan within the overall framework of

systemwide goals. The district plans include a

demographic analysis, a workload forecast, and

a review of the local resources that are submitted

by the VA health care facilities within its jurisdiction. Finally, the district administrators and

councils review and approve the district plans and

submit them to the VA Central Office (218,

426,432).

The first MEDIPP cycle ended in November

1982 and covers fiscal years 1985 to 1990. An internal VA study examined the relationship between technology needs and the MEDIPP plans

that were submitted (45). It found that most of

the medical districts were using the MEDIPP process to request the purchase of specific major medical devices and equipment, in addition to proposals for the creation, expansion, or dismantling

of services. In effect, the MEDIPP process could

serve as a vehicle for identifying and monitoring

the need and demand for various types of major

medical equipment. The study also found that VA

administrators and planners ranked the issue of

device acquisition (and the larger issue of medical technology) fourth in importance among 50

VA-wide issue areas.

These findings confirm and reinforce the potential utility of the MEDIPP process, not only

as a planning tool, but also as an early warning

and tracking system for major equipment adoption and use. As new device and equipment requests begin to surface through medical district

plans, a coherent and well-focused program of

evaluation could be initiated (45). Such evaluations could include broader technology assessment

issues such as devices’ cost effectiveness in the

overall delivery of care.

Another new process that may affect medical

device adoption and use is setting the budgets of

VA medical centers on the basis of diagnosis

related groups (DRGs) (103). Although the VA

has budgeted prospectively because of the congressional appropriations process, the use of a

case-mix measure such as DRGs is intended to distribute the available funds more rationally among

the medical centers.

DRGs classify patients according to principal

diagnosis, presence of a surgical procedure, age,

presence or absence of significant comorbidities

or complications, and other relevant criteria. The

new Medicare prospective payment system for

hospitals is also based on DRGs (see ch. 3). Both

the VA budgeting system and the Medicare payment system use similar mathematical models to

assign patients to DRGs and to allocate resources

among DRGs.

Data sources included all VA discharge abstracts, costs across different service categories

(medical, surgical, psychiatric), the current 470

DRG model,5 and the New Jersey Reimbursement

Schedule. Since the VA has no patient-based

method of assigning costs, the VA used New

Jersey cost data to assign relative DRG weights

to the VA discharges, and these weights were used

for allocation decisions (104).

The VA expects the new budget method to encourage more efficient use of resources within hospitals and to distribute the funds more rationally

because hospitals will receive funds on the basis

of case mix instead of historical budgets. DRGs

are also to be used in VA utilization review and

quality assurance programs (104). Adoption of

medical devices will be more affected by MEDIPP,

although DRG budgeting will probably affect use

of the devices.

—5There are 467 DRGs, plus 3 that require special treatment of the

data: DRG 468 flags an operating room procedure that is unrelated

to the principal diagnosis; DRG 469 represents a patient with a diagnosis that is valid as a principal diagnosis, but not acceptable as

a principal diagnosis; and DRG 470 indicates invalid data.
Ch. 7—Veterans Administration Policies Regarding Medical Devices • 173

DISCUSSION AND POLICY OPTIONS

The VA has the potential to use its extensive

procurement to influence the type and price of

medical devices that are developed and marketed.

Although the VA appears to have obtained lower

prices because of purchases from least-cost suppliers, other procedures such as more standardized purchases and volume commitments to device suppliers might result in greater price reductions. In addition, R&D evaluation, and procurement have been separate, unintegrated activities

within the VA. The potential of the VA’s leverage

has not been realized in stimulating the development of certain types of devices. Nor have the

results of the VA’s own R&D and evaluation

activities been systematically incorporated into the

VA’s procurement and adoption decisions.

In an attempt to coordinate these activities, the

VA is discussing an administrative reorganization

that would put the Rehabilitation R&D Service,

the Prosthetic and Sensory Aids Service, and the

VA Prosthetics Center in one line (39). The following sections offer options for specific improvements within the areas of R&D, testing and evaluation, procurement, and adoption and use of

medical devices by the VA health care system.

Research and Development

To give increased focus to its rehabilitation research efforts, the VA in 1973 organized the Rehabilitation R&D Service. More recently, the VA

has established rehabilitation R&D centers that

are affiliated with engineering schools (two at

present, six more planned by 1986) for broader

outreach. However, when inflation is taken into

account, the VA’s funding commitment to R&D

has been stable or declining. Veterans’ service

organizations have expressed concern about effective cutbacks in R&D budgets, especially in the

areas of prosthetics research and research on sensory aids for the blind and hearing-impaired.

Option 1: Increase the VA’s funding for rehabilitative research that is focused on longer term

development of devices.

The appropriate placement of rehabilitation

R&D of this type could be at the rehabilitation

R&D centers, at the VA Prosthetics Center, or at

both, depending on the goals of the Rehabilitation R&D Service. The rehabilitation R&D centers

at Hines and Palo Alto are connected with their

local engineering communities. The primary mission of these centers is to apply advanced technology to assist physically handicapped veterans

with the goal of commercialization of the devices.

The VA Prosthetics Center combines the development of commercially available prosthetics and

sensory aids with clinical activities through an integrated management. Its engineers and professional personnel work closely with patients in several VA medical centers, customizing prosthetics

and generally applying the expertise of the research engineers to present problems. In addition,

within a fixed budget, any decision to channel

more funds to long-term rehabilitative research

would require a determination that such research

was more worthwhile than other uses of these

funds.

Testing and Evaluation

The responsibility for testing and evaluating

medical devices is divided among several VA

organizational units.The Rehabilitation R&D

Service evaluates rehabilitative prototype devices

that are still in the developmental stage. Once the

medical devices are commercially available, the

responsibility for evaluation is split between the

Prosthetic and Sensory Aids Service for rehabilitative devices and the Office of Procurement

and Supply for all nonrehabilitative devices, equipment, and systems purchased by the VA. The

Disabled American Veterans organization has

called the evaluation system fraught with inefficiencies and communication breakdowns. Efforts

of the various organizational units have sometimes overlapped and unnecessarily duplicated

each other.

The absence of internal planning and coordination for its evaluation activities has generally

been recognized by the VA. Recently, the Rehabilitation R&D Service created the Rehabilitation

R&D Evaluation Unit to coordinate and improve

testing of prototype rehabilitative devices, and the

Prosthetic and Sensory Aids Service formed the
174 ● Federal Policies and the Medical Devices Industry

Prosthetic Technology Evaluation Committee to

develop a formal evaluation and coordination

process for commercially available rehabilitative

products. The Office of Procurement and Supply

established the Testing and Evaluation Staff in

1976 to provide evaluations of nonrehabilitative

medical devices, equipment, and supplies. The

evaluations are incorporated into national procurement contract requirements, but are advisory

only. Purchasing decisions still rest with individual hospitals.

These improvements in evaluation processes

may result in more appropriate adoption and use

of medical technologies by the VA. They may also

result in better adoption and use of medical technologies by other Government agencies and by

the private sector through the dissemination of

evaluation findings. Although it is premature to

assess these newly created committees and programs, options for specific improvements are presented below.

Option 2: Encourage the expansion of field testing

of rehabilitative devices by the VA Prosthetics

Center.

The VA Prosthetics Center is charged with performing “compliance testing” on all commercially

available rehabilitative devices for the Prosthetic

and Sensory Aids Service. Devices can undergo

either special laboratory testing or field testing at

VA medical centers, or both.

Field testing is advantageous in that it allows

an evaluation to more accurately assess a device’s

usefulness to the veteran population. Because of

organizational difficulties, however, the VA Prosthetics Center has never used field testing to its

fullest possible extent.

Until fiscal year 1984, there was no line authority from the VA Prosthetics Center or from the

Prosthetic and Sensory Aids Service to the VA

medical centers, where the field evaluations are

performed. Absence of line authority had resulted

in a loss of control by the testing units over adherence to protocols and reporting of evaluation data

and often created initial resistance to cooperation

in device studies.

The new Prosthetic Technology Evaluation

Committee, which includes representatives from

all the concerned organizational units within the

VA, is mandated to classify devices into groups

which will determine the types of evaluations that

the devices will undergo. This committee will need

to establish some internal control over the VA

medical facilities to assure adherence to evaluation protocols and the collection of accurate data

during expanded field studies.

Option 3: Require the VA to conduct more comparative evaluations before purchasing commercially available devices.

Evaluations of devices by the Testing and Evaluation Staff of the VA’s Office of Procurement and

Supply are usually internal “consumer research”

efforts that take the form of user surveys. Although not scientifically rigorous, they do provide an information base for purchasing by individual VA medical centers. The VA estimates that

only about 20 percent of its medical centers strictly

adhere to purchasing decisions based on these

evaluations. However, results of the evaluations

are also routinely requested by private hospitals,

nursing homes, and State and local governments.

Evaluative information would be improved if

more comparative evaluations that identified the

positive and negative consequences of purchase

and use of particular products were undertaken.

Product quality features—such as safety, durability, and performance—could be more closely

matched with cost considerations. More valid

results would also result from evaluating larger

samples.

Although the VA currently prohibits explicit

comparison of one product with another, the

Testing and Evaluation Staff has attempted some

group evaluations of classes of devices. The primary obstacle to expanding these efforts has been

staffing and budgetary constraints. These constraints might have to be eased in order to provide better evaluative information for VA purchasing decisions.

Procurement

Available evidence indicates that the VA’s centralized procurement programs, through various

contract and distribution mechanisms, have for

the most part created favorable prices for medi-
Ch. 7—Veterans Administration Policies Regarding Medical Devices ● 175

cal equipment and supplies for the VA medical

centers, Some policies, like the most favored customer clause, almost certainly reduce the VA’s

equipment procurement costs, but at the same

time have the effect of increasing the prices that

private buyers must pay for medical equipment.

At least one policy, the VA’s refusal to provide

volume commitments to contractors, probably

results in the VA’s not getting the lowest prices

possible for some medical devices. Other policies

are more ambiguous with respect to their impact

on procurement costs.

A greater problem for the VA is the extent to

which the VA medical centers fail to use centralized procurement channels. VA medical facilities now purchase about 39 percent of their supplies and equipment on the open market, up from

10 percent in the early 1960s. This individual purchasing reduces the advantages available to the

VA as a large institutional buyer.

Option 4: Encourage the VA to increase the proportion of its procurement of equipment and

supplies by centralized contracts to realize

lower costs from the VA’s leverage in the marketplace.

Combining quantity purchases of equipment

and supplies on a national basis through centralized procurement could result in lower product costs through price discounts, Centralizing

more device purchases could increase the VA’s

buying power and could lead to even greater price

discounts.

There are problems, however, in getting physicians to support more centralized procurement.

As part of the effort to retain physicians on staff,

it has been the practice of the VA since the 1960s

to allow physicians to choose their own brands

of medical equipment and supplies. The difficulty

of achieving physician/user acceptance of one specific type of medical equipment is a substantial

obstacle to increasing centralized procurement.

Use of consensus groups might be one mechanism to help physicians reach agreement, or perhaps hospital administrators could be given greater

authority. The extent of disagreement among physicians regarding the desirability of particular

brands or models of medical equipment varies

depending on the type of equipment, the number of manufacturers, and other less tangible

factors.

Adoption and Use

Because of incentives to overadopt in some

areas and concurrent financial constraints in others,

the VA has experienced sporadic patterns of adoption and use of devices and other technologies that

have led to a distribution of resources that may

not be equitable or efficient across geographic

areas or types of facilities. For example, some

types of major medical equipment, such as CT

scanners, may have been underadopted by the VA

because of political pressures to contain costs. On

the other hand, by statute, the provision of rehabilitative devices to veterans is unlimited. As

a result, resources have been drained away from

other parts of the VA’s health care budget as costs

for rehabilitative devices have expanded.

Option 5: Encourage development of comprehensive evaluations of major medical equipment

as part of the VA> strategic planning process.

The VA lacks systematic methods for distributing major new medical equipment among its

medical centers and within its districts. The new

MEDIPP (Medical District Initiated Program

Planning) process is an attempt to create a decentralized long-range strategic planning process in

which plan development responsibilities are assigned to the VA’s 28 medical districts. The MEDIPP

process could serve as a vehicle for identifying and

monitoring the need and demand for various types

of major medical equipment. A coherent, focused

evaluation program could then be initiated to

guide the adoption and use of new medical equipment within the VA.

In June 1983, the VA’s Chief Medical Director

formed a High-Technology Assessment Group to

determine future VA policy on the acquisition of

major new technologies. Comprehensive technology assessments have not as yet been used extensively in the VA health care system. The VA continues to face the constraints of stable or declining

health care budgets, and the use of analytical

methods to evaluate the health and economic effects of technologies could assist in developing in-
176 . Federal Policies and the Medical Devices Industry

formation for allocating health care resources useful information. But decisions about device

more effectively and equitably than in the past. adoption and use would still require judgments

The process of conducting such evaluations would about factors such as equity and ethics that are

raise relevant issues and the results might provide difficult to incorporate into an analysis.
Appendixes
Appendix A.— Method of the Study

On June 17, 1982, OTA’s Technology Assessment

Board approved the assessment entitled “Federal Policies and the Medical Devices Industry, ” to begin September 1, 1982. The proposal stated that the study

would address gaps in basic information about the

medical devices industry and would examine present

and proposed Federal policies that influence the sector.

During the planning period that preceded the study,

OTA staff consulted with industry trade associations,

consumer groups, and Federal agencies for two purposes: to seek suggestions for members of the study’s

advisory panel and to identify issues in the field. An

advisory panel guides OTA staff in selecting material

and issues to consider and reviews written work, but

the panel is not responsible for the content of the final

report.

The advisory panel selected for this assessment consisted of members from different segments of the

industry—large and small companies, medicine, nursing, hospital administration, economics, policy analysis, law, and consumer advocacy. Richard R. Nelson

of Yale University chaired the panel, and two other

members, Joyce Lashof and Rosemary Stevens, served

concurrently on the standing Health Program Advisory Committee. At the beginning of the study, the

staff compiled a bibliography and gained familiarity

with major issues and with sources of data on companies that make up the industry. This effort was aided

by a background paper prepared by Anthony A.

Romeo and by a September meeting with company executives arranged by the Health Industry Manufacturers Association. The study was also considered at

the September meeting of the Health Program Advisory Committee, which advised that the perspectives

of consumers and of different segments of the industry be sought.

At the first panel meeting, on October 7, 1982, discussion centered on the overall study plan and on major policy areas, especially payment for the use of medical devices and premarket regulation by the Food and

Drug Administration (FDA). In order to illuminate certain policies and to gain greater insight into certain

segments of the industry, it was decided to select specific medical devices for more detailed case study. The

panel discussed criteria for selecting the case studies,

including the importance of certain policies. Also

raised was interest in the process by which devices are

developed and brought to market.

Following the panel meeting, OTA staff selected six

case studies: the Boston elbow, contact lenses, hemodialysis equipment, nuclear magnetic resonance imaging, technologies for urinary incontinence, and wheelchairs. It was also decided to produce a separate

technical memorandum on the policies of the Veterans

Administration (VA) concerning medical devices, since

the relevant policies of this health care delivery system are both extensive and separate from others. The

technical memorandum was to be prepared by OTA

staff, and the case studies and other background papers

by contractors outside of OTA.

On the basis of advice from the Health Program

Advisory Committee and the advisory panel for this

assessment, two workshops were held at OTA in December 1982: one on December 7 on the purchase and

use of medical devices and the other on December 1.5

on research, development, and marketing of medical

devices. Suggestions for organizations and individuals

to participate were solicited from a wide range of interested parties.

The first workshop, which was chaired by Louise

Russell from the advisory panel, consisted of people

involved in different facets of the purchase and use of

devices, including multihospital organizations, municipal hospital administration, hospital administration

in the VA, hospital bioengineering, handicapped people, and physicians of different specialties (see app. B).

Although their interests varied, the participants shared

the need for better evaluative information on devices,

concern about postmarketing surveillance of device

problems and standard setting for devices by FDA, and

interest in devices that meet a clinical need instead of

overly sophisticated ones.

The participants at the second workshop, chaired

by Richard Nelson of the advisory panel, were involved in the invention, development, and marketing

of devices as individual inventors, managers in large

companies, university researchers, or marketing representatives (see app. B). Discussion in this workshop

centered on problems in commercializing devices, especially in securing funding to develop prototype devices;

the role of Federal regulation, including FDA, VA, and

the Patent Office; the role in the development process

of different actors, such as individual inventors, small

firms, and large firms. On the basis of this discussion,

the OTA staff decided to compile vignettes on the development process from inventors of different devices

and from different organizations.

The staff next prepared a draft status report, which

presented information gained up to that point in the

study on the industry and on Federal policies regarding payment, FDA regulation, the VA, research and

development, patents, and international trade. The

status report was the major topic of the second panel

meeting held at OTA on March 3, 1983. The discussion pointed out the advisability of focusing the final

report of the assessment on policies specific to medi179
180 . Federal Policies and the Medical Devices Industry

cal care and, within those policies, on matters related

to medical devices.

Considerable discussion at the panel meeting also

surrounded FDA regulation of medical devices. Because of the importance of this policy area, a workshop on regulation under the 1976 Medical Device

Amendments was held at OTA on May 19, 1983. Participants included attorneys and other policymakers

from Federal agencies, consumer groups, and private

firms who had been involved in drafting and implementing the legislation (see app. B). The workshop discussed the intentions of the framers of the law, the

evolution of the bill as it went through the legislative

process, and its implementation as practical problems

were faced by FDA.

At its third meeting, on August 4, 1983, the advisory panel discussed the revised draft of the status report as well as drafts of a case study and background

paper that had been received. The panel noted that

the report would have to take into account the changes

in payment occasioned by Medicare’s forthcoming use

of diagnosis related groups. The final draft of the status

report was sent to the requesting congressional committees in order to inform them of the progress and

components of the study.

During the fall and early winter, drafts of the remaining case studies and background papers were received, sent to the advisory panel and other experts

for review, and revised by contractors. The material

was therefore available to OTA staff as they were preparing the first draft of the final report. In March 1984,

that draft was sent to the advisory panel, the Health

Program Advisory Committee, and 75 other reviewers

who are experts in fields related to different aspects

of the study.

The draft report was discussed at the March 31

meeting of the Health Program Advisory Committee

and at the fourth and final meeting of the advisory

panel on April 3. The committee advised that more

note be taken of devices for which adoption and use

have been insufficient. The advisory panel concentrated on the summary chapter, FDA regulation, and

policy options. After the meeting, OTA staff revised

the final report based on comments received from the

panel and other reviewers and in early May sent the

revised summary chapter to the advisory panel and

the Health Program Advisory Committee. The revised

report was reviewed within OTA and in mid-May was

submitted for approval to the Technology Assessment

Board.

Several documents are being published in connection with the assessment: the main report (of which

this appendix is a part), a booklet summarizing the

main report, a technical memorandum on policies of

the VA, a background paper of inventors’ vignettes,

and six case studies. In addition to this report and the

summary, the following publications will be available

through the U.S. Government Printing Office:

●

●

●

●

●

●

●

●

Inventors’ Vignettes of the Development of Medical Devices, edited by OTA staff.

Medical Devices and the Veterans Administration, by OTA staff.

Technologies for Managing Urinary Incontinence,

by Joseph Ouslander and Robert L. Kane, University of California, Los Angeles.

The Boston Elbow, by Sandra J. Tanenbaum,

Massachusetts Institute of Technology.

The Contact Lens Industry: Structure, Competition and Public Policy, by Leonard G. Schifrin,

College of William and Mary.

Nuclear Magnetic Resonance Imaging Technology: A Clinical, Industrial, and Policy Analysis,

by Earl P. Steinberg and Alan B. Cohen, Johns

Hopkins Medical Institutions.

The Hemodialysis Equipment and Disposable Industry, by Anthony A. Romeo, University of

Connecticut.

The Market for Wheelchairs: Innovations and

Federal Policy, by Donald S. Shepard and Sarita

L. Karen, Harvard School of Public Health.

In addition, papers were prepared on contract to

OTA to provide background information for the main

report and are available through OTA in limited quantities:

●

●

●

●

●

●

“Capital Markets, Government Regulation, Tax

Policy, and the Financing of Medical Device Innovations,” by James R. Barth and Joseph J.

Cordes, with Michael Bradley, George Washington University.

“Governmental Barriers to International Trade in

Medical Devices in the United States, United

Kingdom, France, the Federal Republic of Germany, Canada, Japan, and Mexico, ” by Kaye,

Scholer, Fierman, Hays & Handler, Washington,

DC.

“Innovative Activity in the Medical Devices Industry,” by Anthony A. Romeo, University of

Connecticut.

“Medical Device Standards and International

Trade, ” by Kornmeier, McCarthy, Lepon &

Harris, Washington, DC.

“The Impact of Federal and State Regulatory Programs on the Ambulatory Laboratory Testing Industry and the Demand for Instrumentation,” by

Hope S. Foster, O’Connor & Hannan, Washington, DC.

“The Relationship of FDA, PHS, and HCFA

Regarding Medical Device and Organ Transplant
App. A—Method of the Study • 181

— .. -—- —

Technologies,” by Dennis J. Cotter, Georgetown netic Resonance (NMR) in the United Kingdom, ”

University. by John Hutton, University of York, England.

• “The Role of the Government in the Research, De- ● “Veterans Administration Procurement and the

velopment, and Commercialization of Computed Market for Medical Equipment, ” by Ralph M.

Tomography (CT) Scanning and Nuclear Mag- Bradburd, Williams College.
Appendi x —Acknowlegements and

Health Program Advisory Committee

—.——.——.-—..--—— _ ——.— — ..— —— . . — —— .-— - - .- - — - —————.—-—— .

This report has benefited from the advice and review of several other people in addition to the advisory

panel. The staff would like to expresss its appreciation to the following people for their valuable guidance.

Emily Arakaki Warren Hyer

U.S. Department of Commerce Biomedical Network,Inc.

Washington, DC Lawrenceville, NJ

Claude Bandy Michael Kerney

U.S. Department of Commerce Berkeley, CA

Washington, DC

Carl Blozan

U.S. Food and Drug

Rockville, MD

Robert Britain

U.S. Food and Drug

Silver Spring, MD

Gil Devey

Washington, DC

Fred Downs

Philip Marcus

U.S. Department of Commerce

Administration Washington, DC

Robert C. McCune

National Electrical Maufacturers Association

Administration Washington, DC

Robert S. Musitano

Dun & Bradstreet

Washington DC

Wayne Roe

U.S. Veterans Administration

Washington, DC

Lily Engstrom

National Institutes of Health

Bethesda, MD

Marion Finkel

U.S. Food and Drug Administration

Rockville, MD

Richard Flaherty

Health Industry Manufacturers Association

Washington, DC

Susan Foote

University of California, Berkeley

Berkeley, CA

Ghislaine Francis

U.S. Department of Commerce

Washington, DC

Margaret Gianinni

U.S. Veterans Administration

Washington, DC

Jonathan Gold

Office of Health Planning

U.S. Public Health Service

Rockville, MD

Health Industry Manufacturers Association

Washington DC

Paul Ryser

IMS America, Ltd.

Rockville, MD

William K. Scheirer

U.S. Small Business Administration

Washington, DC

F. M. Scherer

Swarthmore College

Swarthmore, PA

Al Schnupp

U.S. General Accounting Office

Rockville, MD

William Starr

U.S. Department of Commerce

Washington, DC

George Willingmyre

Health Industry Manufacturers Association

Washington, DC

Dennis Wyant

U.S. Veterans Administration

Washington, DC

182
App. B—Acknowledgments and Health Program Advisory Committee • 183

_ —

Workshop on the Purchase and Use of Medical Devices, Dec. 7, 1982

Robert Berenson John Matoole

Washington, DC Veterans Administration Medical Center

Frank Bowe Omaha, NE

Cedarhurst, NY

Dennis Cotter

Georgetown University Health Policy Center

Washington, DC

Danny Foutch

Hospital Corp. of America

Nashville, TN

Pradeep Gupte

James Mongan

Truman Medical Center

Kansas City, MO

Louise Russell

The Brookings Institution

Washington, DC

Kent Samuelson

Salt Lake City, UT

Westchester-County Medical Center William Schneider

Valhalla, NY Kaiser-Permanente Medical Care Program

Ralf Hotchkiss Oakland, CA

Oakland, CA

Phyllis Leppert

Columbia-Presbyterian Medical Center

New York, NY

Workshop on Research, Development, and Marketing of Medical Devices, Dec.

William Adams

Surgilite International, Inc.

Long Beach, CA

Perry Blackshear, Jr.

Massachusetts General Hospital

Boston, MA

Thomas Carney

Metatech & Bioferm

Northbrooke, IL

Wilson Greatbatch

Greatbatch Enterprises, Inc.

Clarence, NY

Richard Nelson

Institute for Social and Policy Studies

Yale University

New Haven, CT

William Partridge

University of Utah Research Institute

Salt Lake City, UT

Richard Rettig

Illinois Institute of Technology

Chicago, IL

Walter Robb

Medical Systems Operations

General Electric Co.

Milwaukee, WI

Aron Safir

University of Connecticut Health Center

Farmington, CT

15,1982
184 ● Federal Policies and the Medical Devices Industry

.—. . — ---- ---- —... —-—

Workshop on Standards, Aug. 17, 1983

Russell J. Arnsberger

Becton Dickinson & Co.

Washington, DC

E. Ronald Atkinson

American Hospital Supply Corp.

Evanston, IL

Robert Avrutik

Philips Medical Systems, Inc.

Shelton, CT

Richard G. Flaherty

Health Industry Manufacturers Association

Washington, DC

Robert C. Flink

Medtronic, Inc.

Minneapolis, MN

Thomas E. Kimble

DuPont Clinical & Instrument System Division

Wilmington, DE

Harold May

Ohio Medical Products

Madison, WI

Thomas D. Nickel

Travenol Laboratories, Inc.

Deerfield, IL

George T. Willingmyre

Health Industry Manufacturers Association

Washington, DC

Henry Wishinsky

Miles Laboratories, Inc.

Elkhart, IN

HEALTH PROGRAM ADVISORY COMMITTEE

Stuart H. Altman*

Dean

Florence Heller School

Brandeis University

Waltham, MA

H. David Banta

Deputy Director

Pan American Health Organization

Washington, DC

Carroll L. Estes**

Chair

Sidney S. Lee, Committee Chair

President, Milbank Memorial Fund

New York, NY

Harvey V. Fineberg

Dean

School of Public Health

Harvard University

Boston, MA

Melvin A. Glasser***

Director

Health Security Action CouncilCommittee for National Health Insurance

Washington, DC

Patricia King

Department of Social and Behavioral Sciences

School of Nursing

University of California, San Francisco

San Francisco, CA

Robert Evans

Professor

Department of Economics

University of British Columbia

Vancouver, BC

Rashi Fein

Professor

Department of Social Medicine and Health Policy

Harvard Medical School

Boston, MA

Professor

Georgetown Law Center

Washington, DC

Joyce C. Lashof

Dean

School of Public Health

University of California, Berkeley

Berkeley, CA

Alexander Leaf

Professor of Medicine

Harvard Medical School

Massachusetts General Hospital

Boston, MA
App. B—Acknowledgments and Health Program Advisory Committee ● 185 —

Margaret Mahoney**** Dorothy P. Rice

President Regents Lecturer

The Commonwealth Fund Department of Social and Behavior Sciences

New York, NY School of Nursing

Frederick Mosteller University of California, San Francisco

Professor and Chair San Francisco, CA

Department of Health Policy and Management Richard K. Riegelman

School of Public Health -

Harvard University

Boston, MA

Norton Nelson

Professor

Associate Professor

George Washington

School of Medicine

Washington, DC

Walter L. Robb

University

Department of Environmental Medicine Vice President and General Manager

New York University Medical School Medical Systems Operations

New York, NY General Electric

Robert Oseasohn

Associate Dean

University of Texas, San Antonio

San Antonio, TX

Nora Piore

Senior Advisor

The Commonwealth Fund

New York, NY

Mitchell Rabkin*

President

Beth Israel Hospital

Boston, MA

Milwaukee, WI

Frederick C. Robbins

President

Institute of Medicine

Washington, DC

Rosemary Stevens

Professor

Department of History and Sociology of Science

University of Pennsylvania

Philadelphia, PA

*Until April 1983.

**Until March 1984.

***Until October 1983.

****Until August 1983.

25-406 0 - 84 - 1 3
Appendix Cm—The Innovative Process in the

Medical Devices Field

Introduction

As a society, we value technological progress—the

continual “introduction to practice of new and more

useful ways of serving human purposes” (262). In the

health field, technological progress is often embodied

in the introduction of new medical devices. Despite

its importance, there has been little systematic investigation of the process of technological change for medical devices. How and by whom do medical devices

get developed? And what factors influence their development?

There are, of course, many stories about the introduction of specific new devices, such as electronic fetal

monitors (410), gastric freezing (114), gastroendoscopes (448), and computed tomography (CT) scanners (348). These individual cases demonstrate the

diversity of developmental pathways taken. They suggest that simple generalizations of the process are impossible. Yet, some elements of the process may be

common to all medical devices and, indeed, to all new

technologies.

The basic unit of technological change is innovation—a new device, product, or process introduced to

practice for the first time (223,182). Innovation is also

widely used to refer to the process by which technological change occurs (232). In this OTA assessment,

“innovation” refers to the newly introduced technology and “innovative process” to the process by which

innovations find their way into practice. This appendix explores the process of technological change in general, with emphasis on the questions of who develops

innovations and under what conditions the innovative

process occurs.

Innovations are valued for their capacity to increase

productivity or the quality of consumption (274).

Those innovations largely affecting production processes have been called process innovations, while those

intended for sale are product innovations (438). New

medical devices are product innovations, although

they may change the process of medical care.

One important view of the innovative process is that

it consists of four essential functions (274):1

‘There are several other models of the “innovative process” that focus on

the chronological stages rather than on critical functions. Schumpeter defined

technical change as having three steps: invention, innovation, and imitation

(or diffusion) (274). A recent study of the Organization for Economic Cooperation and Development has identified four stages of innovation: conception, reduction to practice (i.e., prototype), startup, and expansion (diffusion) (236). These alternative characterizations of the innovative process do

not contradict one another; they highlight the points in the process of interest to each author.

●

●

●

●

Invention—the act of insight by which a new and

promising technical possibility is recognized and

worked out (at least mentally and perhaps also

physically).

Development—the sequence of detail-oriented

technical activities, including testing by trial and

error, through which the original concept is modified and perfected until it is commercially viable.

Entrepreneurship—the decision to go forward

with the effort, the organization of it, and the securing of funding for it.

Investment—the act of risking funds for the

venture.

For the innovative process to succeed in producing

an innovation, each of these four components is necessary, but the mix may differ widely among applications. Some innovations are the result of sudden insights, with little developmental work needed; others

may require a laborious and slow development phase

with high levels of investment. Nevertheless, all innovative processes contain each of these components

to a greater or lesser extent.

When and Where the Innovative

Process Occurs

Theories of innovation rest largely on underlying

views of the innovative process as either deterministic,

individualistic, or serendipitous (182). The deterministic view holds that innovations come forth when

the conditions are right; the individualistic theory

stresses the importance of the innovator (an individual or organization) in bringing forth and carrying

through an idea; and the serendipity approach stresses

the stochastic nature of the process of technological

change (182).

There is, of course, some truth in each of these approaches. Variability, complexity, and uncertainty are

the hallmarks of innovative processes (231). These

three factors have substantial influence on the effectiveness of policies intended to affect the rate and direction of technological change (232). Innovative processes vary widely among industries and institutions

and are not well characterized by simple methods.

However, a brief description of how medical and surgical procedures that use medical devices come into

being may highlight the characteristics of the innovative process in medicine.2

‘The description presented here is adapted from appendix D of an OTA

report entitled Strategies for Medical Technology Assessment (351).

186
App. C—The Innovative Process in the Medical Devices Field ● 187

Medical and surgical procedures, which often involve the use of medical devices, usually begin as usergenerated (e.g., physician-generated) innovations. An

innovative procedure may involve the modification of

an existing procedure (usually in accompaniment with

modifications of the devices being used) for application to a new use.

Innovations in procedures frequently arise in academic or academic-associated centers, where physical

and professional resources are readily available; a research, innovation-seeking atmosphere is encouraged;

and contacts with others in the field extend not only

nationally, but also globally. Innovators in such settings know how to present the innovations in a manner that will be technically acceptable and have the

prestige that gives them access to professional meetings

and journals to publicize their results. Their presentations and publications not only diffuse the innovation

to a wider audience, but more importantly, begin to

legitimize it. Depending on the claimed innovation’s

nature, usually defined in terms of how the innovation will revolutionize or at least substantially influence the related area of medical or surgical practice,

other academic centers will begin to pursue it.

At some point in the innovative process, a prototype

device must be developed. This activity may occur in

a variety of settings including the academic center, a

hospital, a medical device firm, or even a home laboratory. The development and refinement of a prototype can be a costly and time-consuming part of the

innovative process.

At this point, several U.S. Government agencies

may enter the picture. The National Institutes of

Health (NIH) may provide support for the innovator

and researchers in other health centers through randomized clinical trials, most likely conducted in some

of the clinical research centers funded by NIH. A new

device or modification of an existing device requires

the Food and Drug Administration’s (FDA) approval.

Increasingly, FDA approves the use of investigational

devices for limited testing at the same centers that NIH

supports as clinical research centers (or at least to the

health institutions in which these designated centers

are located).

FDA must make a determination of safety and efficacy for market clearance of the device under review.

FDA will often make its decision long before NIH

reaches a decision and terminates funding for the clinical trials. FDA’s decision may rest on the narrow question of the technical functioning and safety of the

device. Release of the device to the general market,

once premarket approval is given, also tends to speed

up the diffusion of the procedure that NIH may be

studying.

This result, in turn, places more pressure on the

Health Care Financing Administration (HCFA) to reimburse for the procedure. Sooner or later, HCFA may

receive a request for reimbursement of the new procedure and will consider information from any clinical trials for evidence of safety and efficacy, but only

after the device has been approved for marketing by

FDA.

Conditions Affecting the

Innovative Process

Despite the variability and uncertainty of the innovative process, there are institutional and other contextual conditions that may influence the process in

systematic ways. These conditions fall into four categories:

● conditions affecting the market for the innovation,

• conditions affecting the ability to appropriate the

benefits of the effort to produce the innovation,

. conditions affecting the availability of resources

to invest in the innovation, and

. conditions affecting the availability and organization of technical and entrepreneurial know-how.

Conditions Affecting the Market for Innovation

The market for an innovation depends on the willingness of each potential user to pay for its benefits.

If a new medical device is to survive after a trial, it

must be perceived as worthwhile by the people or

organizations who will decide whether or not it will

be used (232). Thus, the perceived need for and potential benefits of a new device determine the size of

the market. Even the “user/innovator,” the individuals

or organizations that go about solving their own problems through technological change (446), are likely to

assess the potential benefit of the innovation to themselves and to others in their decisions to devote time

and resources to solving a problem.

Both the size and organization of the market can be

important in determining the willingness to pay for

useful innovations (268). For example, potential economies of scale in the production of medical services

in certain devices may not be realized because of the

small scale of medical care providers (168). If smallscale providers are not organized to share services,

then the full benefits of the device cannot be realized

by potential users, and the device is unlikely to succeed. Yet, if the potential cost savings are high enough,

the availability of a new technology may, with some

delay, actually bring about a change in the organization of the market that allows for its adoption (268).
188 ● Federal Policies and the Medical Devices Industry

Although it is difficult to sort out the many factors

contributing to the emergence of newly integrated

health care organizations, changing medical technology may be one cause.

The importance of the market in stimulating innovation is indicated by the fact that 60 to 90 percent of

successful innovations across many fields have been

developed in response to the perceived needs of the

market or of users (437). Any factors affecting the size

of the market for an innovation, such as changes in

the prices of close substitutes, changes in the ability

of potential users to pay, and regulatory constraints

on use (263), are likely to affect the innovative process.

In medical care, the market is determined in large

part by mechanisms of third-party reimbursement for

care (see ch. 3 for more detail). Russell found that the

rate of diffusion of some (but not all) of the medical

device innovations that she studied increased with the

onset of Medicare coverage (265). Recent work indicates that prospective payment approaches can have

some retarding effects on the quantity of new medical

devices adopted by hospitals (448). Thus, the payment

procedures used by insurance companies and other

third-party payers may have an important indirect effect on innovative activity in the medical devices industry.

Conditions Affecting the Innovator’s Ability to

Appropriate Benefits

The need for investment in research, development,

and commercialization implies that a potential innovator must be able to expect a return that will make

the investment worthwhile. s In addition to an evaluation of the potential market, the expected return will

depend on the degree to which the innovators can expect to capture or appropriate these benefits in profits or perhaps even directly as users. The ability to

appropriate benefits affects not only whether innovation results, but also what kind of organization or individual undertakes the innovative activity (445).

One influence on the ability to appropriate benefits

is the market structure of the industry, which influences the rate of imitation and therefore the market

share that an innovator can expect over time. The effect of market structure is controversial. Schumpeter

and Galbraith postulated that industries with a few

dominant firms would be able to appropriate more of

3The innovator’s best guess about the potential market may be wrong, for

uncertainty and failures of human judgment are inherent in the process. Unless

there is some reason to suspect a bias in the direction of error, however, the

investment decision can be assumed to deal with the probability of error

through its tradeoff of expected risk for return. Government policies such

as regulation may increase the level of uncertainty about outcomes of the

innovative effort and therefore increase the level of expected return required

to justify an R&D investment (97).

the benefits of their inventions because they face less

of a threat from imitation and would therefore be more

innovative than highly competitive industries (274).

Other researchers have concluded that high barriers

to entry in an industry, particularly in relation to the

capital investment required to compete, encourage research and development (R&D) by the firms in the industry (66). Fellner has suggested that the effect of

monopoly power on the innovative process may differ between product and process innovations (112).

Firms in industries in which a few firms hold a substantial share of the total market would have less to gain

from introducing cost-reducing process innovations

than would firms in highly competitive industries, and

firms in more competitive fields may have to innovate

to keep pace with rivals. Kamien and Schwartz observed that the greatest degree of innovation occurs

in a market structure where rivalry is greater than in

monopoly but less than in perfect competition (178).

Empirical evidence testing this hypothesis in U.S.

industry is conflicting. Greer and Rhoades found that

the rate of process innovation (as measured by productivity growth) was actually higher in concentrated industries, but Scherer points out that this association

could be the result of a bias in process innovations

toward large-scale operations, which are most likely

to predominate in concentrated industries (134,274).

Romeo, on the other hand, found that firms in concentrated industries adopted numerically controlled

machine tools (a process innovation) more slowly than

firms in more competitive industries (261).

The ability to appropriate benefits from investment

may also depend on the size and level of diversification of the innovating firm. Larger firms with greater

diversification may be able to apply a process innovation across a variety of applications and may therefore be able to recoup investment costs more readily

(230). Empirical studies relating to this hypothesis are

inconclusive (274).

Despite the large number of companies in the medical devices field, especially small ones, concentration

in the medical devices categories is similar to that in

other manufacturing industries. There is some evidence, however, that merger activity in medical devices accelerated during the latter part of the 1970s (see

ch. 2 for details).

Government policies can also affect the extent to

which a developer captures the benefits of an innovation, The patent system is, of course, designed for that

purpose, but its power is limited. It is easy to design

around some areas of technology, such as electronic

circuitry and computer software (142). Also, firms

holding critical patents may refuse to license them, thus

blocking further technological innovations (142). In

short, the ability to appropriate benefits may carry
App. C—The Innovative Process in the Medical Devices Field . 189

with it the ability to resist pressure to apply potential

innovations.

Conditions Affecting the Availability of Resources

Several scholars have noted the increasing institutionalization of R&Din the post-war period (175,182).

Although there is variation across industries and fields

of technologies, organized R&D as opposed to individual efforts have become the predominant source of

innovation in this country as well as others. This trend

toward institutionalization stems at least partly from

the complexity of technology and the increasing need

for financial resources and trained manpower to bring

forth innovations.

Two kinds of resources are needed for R&D: personnel and financial capital. The availability of a pool

of adequately trained personnel capable of carrying

on R&D should become more important to technological innovation as the technology base gains in complexity. This OTA report does not explore issues of

personnel or the role of scientific and technical education as it relates to industrial innovation in general

and to the medical devices industry.

Financial capital can take the form of government

or philanthropic grants and contracts for R&D, funds

generated internally by firms (e.g., undistributed profits), and debt or equity instruments (including venture

capital arrangements). The flow of these funds depends

on the expected return and risk inherent in specific

R&D projects, which in turn depend on the market

and the appropriability of benefits. Government policies also influence the flow of R&D funds and therefore the location of R&D activities and the ultimate

innovations.

As discussed in this OTA report, Government R&D

policies influence not only the kinds of projects that

are initiated, but also the kinds of organizations in

which R&D takes place. Taxation policy also affects

the availability of different kinds of capital. Appendix G discusses the impact of taxation policy on R&D

for medical devices.

Conditions Affecting the Availability of

Technical and Entrepreneurial Know-How

Successful innovation requires the joining of technical and entrepreneurial expertise. Although these

areas of expertise need not reside in a single individual, they must be integrated in an appropriate fashion. Are there conditions or environments that foster

or inhibit the existence and productive use of these

skills?

A great deal of research has been devoted to determining whether or not the size of the firm has any relationship to its ability to develop innovations successfully. The size of the organization can be important

to innovation for several reasons. First, larger firms

may be more able to marshal the technical resources

needed to conduct R&Don complex subjects. Second,

large firms may be able to appropriate the benefits of

innovations more easily than small firms. Third, large

firms may have greater access to capital to finance

R&D than small firms.

Against these possible advantages of large firms is

one major advantage held by small firms. Small firms

may be less burdened by cumbersome organizational

structures that could inhibit coordination and timely

decisionmaking on innovation. The interplay of these

factors has suggested to some that there may be a

threshold size necessary to support the R&D that

results in innovation (203,179). Moreover, this threshold size is likely to vary from industry to industry. Empirical studies of the innovative process do not suggest any systematic patterns of advantage for large

firms. One recent study, which examined 635 product innovations marketed during the 1970s, found that

small firms accounted for approximately 40 percent

of these (124). Other work has found some advantage

to size but, again, only up to some threshold (200).

In a recent study, The Futures Group examined over

8,000 innovations published in trade journals in 1982 ‘

(123). 4 The number of innovations per employee was

1.43 times higher in small firms (500 employees or less)

than in large firms. Innovations were categorized by

Standard Industrial Classification (SIC) code. Rates of

innovation in five medical device codes are presented

in table C-1. With the exception of SIC 3851 (ophthalmic goods), small firms were over twice as innovative

relative to levels of employment as large firms in the

medical device industries.

There is also evidence from a Louis Harris survey

that “the introduction of new medical devices is just

as common in small as it is in large plants” (197).

About one-half of the establishments with 500 or more

employees introduced a significant new medical device

in the last decade, while just under half of the firms

with fewer than 500 employees reported doing so. (Indeed, more than one-half of the very small firms, 1

to 9 employees, reported such an introduction. )

4This study, like others that depend on a sample of published innovations,

is subject to possible selection bias. The bias is most likely in the direction

of overrepresentation of innovations by large firms and more significant innovations. Hence, findings showing smaller firms to be more innovative are

probably strengthened by this bias.
190 ● Federal Policies and the Medical Devices Industry

Table C-1 .—Rates of Innovation in Five SIC Code Medical Devices Categoriesa

Industry

Standard employment in 1977d

Industrial Innovations in 1982 (thousands)

Classification Small Large Small Large Innovations per employee

(SIC) codeb

firmcfirm firm firm small firm : large firm

3693 . . . . . . . 10 5.9 25.0 2.49

3841 . . . . . . . 36 30 11.7 31.5 3.23

3842e33 30 17.9 36.0 2.21

3843 . ........... 2 0 7.1 9.2 NAf

3851 . . . . . . . —2 —9 11.1 18.9 0.38

Total . . . . . 83 86 53.7 120.6 2.17

alnnovations were published in 1982 trade journals.

%he five SIC codes areas follows: 1) SIC 3693(X-ray and electromedical equipment), 2) SIC 3841 (surgical and medical instruments),

3) SIC 3842 (surgical a pliances and supplies), 4) SIC 3843 (dental equipment and supplies), and 5) SIC 3851 (ophthalmic goods).

See ch. 2 for more in ormation. F

csmall firms have fewer than 500 emPloYees.

deployment in 1977 is Used because a lag in journal publication of 4.3 years between invention and innovation was found

in a detailed analysis of 375 innovating firms.

eThis ~alysis e~~ludes four innovations in SIC 3842, &cause the inno@ing companies could not be found in published directories,

f NA indicates information not available.

SOURCE: The Futures Group, “Characterization of Innovations Introduced on the U.S. Market in 1982,” contract report prepared

for the US. Small Business Administration, contract No. SBA43050-OA-82, Glastonbury, CT, March 1984.

On balance, it appears that in the medical device industries and types of technologies in the most approfield as in industry in general, small firms play an im- priate setting for bringing forth innovations. Scherer

portant role in spurring innovation, but the evidence concludes that the issue of small or large may be iris limited by the lack of consistent or validated meas- relevant when what is needed is a variety of environures of innovation and of any standardized criteria for ments capable of responding to technological opporassessing the relative importance of innovations. In ad- tunities wherever they arise (274).

dition, there maybe a great deal of variation among
Appendix D.—Patent Policy Regarding Medical Devices

Introduction

The U.S. patent system started with British-based

colonial patent systems which continued after the

American Revolution. It is derived from a specific provision in the Constitution (357):

The Congress shall have the Power . . . to promote

the Progress of Science and useful Arts, by securing

for limited Times to . . . Inventors, the exclusive . . .

Right to their . . . Discoveries.

The Supreme Court has interpreted this clause in our

Constitution to mean that (132):

The Congress in the exercise of the patent power

may not overreach the restraints imposed by the stated

constitutional purpose. Nor may it enlarge the patent

monopoly without regard to the innovation, advancement or social benefit gained thereby. Moreover, Congress may not authorize the issuance of patents whose

effects are to remove existent knowledge from the public domain, or to restrict free access to materials

already available. Innovation, advancement, and

things which add to the sum of useful knowledge are

inherent requisites in a patent system which by constitutional command must promote the progress

of . . . useful Arts. This is the standard expressed in

the Constitution and it may not be ignored. And it

is in this light that patent validity requires references

to a standard written into the Constitution . . .

There are four types of property rights in information, or intellectual property—patents, trade secrets,

trademarks, and copyrights. Patents give the right to

exclude others from using inventive concepts during

the life of the patent. Trade secrets, traditionally under

State not Federal law, give the owner of a technical

or commercial secret the right to prevent someone with

access to the secret from disclosing it or using it for

personal gain. But if the secret can be discovered independently or is discovered by legitimate means (e.g.,

from analysis of the product), there is no protection.

Trademarks give merchants the right to restrict their

use by others who might benefit from the exploitation

of established products (e.g., Coca Cola®, Darvon®,

SweetnLow®). Copyrights provide the right to exclude

others from copying the form of a work of art or a

writing, but do not prevent others from using the ideas

expressed in the copyrighted work (347).

Lately, a property right called a “tangible research

property” has emerged separate and distinct from

patents, copyrights, trademarks, and trade secrets. For

example, in March 1982, Stanford University developed a separate policy on tangible research property

to protect Stanford’s ownership of “tangible (or corporeal) items produced in the course of research projects.” This policy covers such items as “biological

materials, computer software, computer data bases,

circuit diagrams, engineering drawings, integrated circuit chips, prototype devices and equipment, etc. ”

(289).

There are four types of patents, one of which, the

“utility” patent, applies to useful processes, machines,

manufactured articles, or compositions of matter. “Design” patents protect ornamental designs. “Plant”

patents apply to asexually reproduced plants other

than tubers or a plant found in an uncultivated state.

“Plant variety protection certificates” provide patentlike protection to sexually reproduced plants. Certificates are administered through the U.S. Department

of Agriculture. Utility, design, and plant patents are

administered through the Patent and Trademark Office in the U.S. Department of Commerce (347).

The law on utility patents is as follows (347):

An invention, to-be patentable, must be useful

and must be a process, machine, manufactured

good, or composition of matter.

A patent can be granted only for an invention

that, at the time of the claim: 1) was not known

to others, and 2) was not so obvious that a person of ordinary skill in the art could have made

the same invention.

A patent can be granted only to the inventor(s).

A patent gives the owner the right to exclude

others from making, using, or selling the invention in the United States. (There are some important conflicts between the patent laws of the

United States and those of other countries.)

A patent is granted for 17 years.

About 100,000 patent applications are filed per year,

of which about two-thirds are eventually granted. The

average time from application to action is about 2

years. During this time, a patent examiner determines

whether the invention is novel and not obvious (see

above), primarily by searching files within the Patent

and Trademark Office that contain information on

U.S. and foreign patents and on literature such as professional journals (347).

Tables D-1 and D-2 summarize the number of patents granted by the U.S. Patent Office between 1970

and mid-1983. In table D-1, patents are enumerated

by the date of the patent grant, while in table D-2, successful patent applications are listed by the dates when

patent applications were first filed. The date when an

application is filed is a more accurate reflection of

when the technology was developed. Fluctuations in

data based on application dates are more likely to reflect changes in technological activity, since such fluctuations would be unaffected by changes in the Patent and Trademark Office’s processing of patent

applications. For example, the 1979 patent grant data

191
Table D-l.–Patent Activity by Date of Patent Grant, U.S. and Foreign Origin, 1970-83

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983

Total. . . . . . . . . . 64,429 78,317 74,810 74,143 76,278 72,002 70,226 65,269 66,102 48,854a 61,819 65,771 57,889 24,383b

U.S. origin . . . . . 47,077 55,984 51,524 51,504 50,650 46,713 44,277 41,484 41,254 30,081 37,356 39,223 33,896 14,144

(Percent) . . . . (73) (71) (69) (69) (66) (65) (63) (64) (62) (62) (60) (60) (59) (58)

Foreign origin.. 17,352 22,333 23,286 22,639 25,628 25,289 25,949 23,785 24,848 18,773 24,463 26,548 23,993 10,239

(Percent) . . . . (27) (29) (31) (31) (34) (35) (37) (36) (38) (38) (40) (40) (41) (42)

aThi~ number i~ artificially low because the patent and Trademark Office issued fewer patents than normal becauseof alackof fundsto print patelltS.

blncludes data only to June 1963.

SOURCE: U.S. Department of Commerce, Patent and Trademark Office, Office of Technology Assessment and Forecast, “OTAF Custom Report, All Technologies Report, 1/1963-6/1983” (mimeo), 1983.

Table D-2.–Patent Activity by Date of Patent Application, U.S. and Foreign Origin, 1970-83

1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983

Total. . . . . . . . . . . . ‘65,942 66,353 63,356 66,278 66,381 65,807 65,695 65,697 64,931 64,081 58,228a 23,816a 1,647a 1a, b

U.S. origin . . . . . . . 45,851 45,580 42,429 42,733 41,830 42,198 41,566 40,652 39,222 37,978 34,403 14,765 1,150 0

(Percent) . . . . . . (70) (69) (67) (64) (63) (64) (63) (62) (60) (59) (59) (62) (70) (o)

Foreign origin. . . . 20,091 20,773 20,927 23,545 24,551 23,609 24,129 25,045 25,709 26,103 23,825 9,051 496

(Percent) . . . . . . (30) (31) (33) (36) (37) (36) (37) (38) (40) (41) (41) (38) (30) (100)

aData incomplete because of lag time between application and aPPrOval.

blncludes data only to June 1983.

SOURCE: U.S. Department of Commerce, Patent and Trademark Office, Office of Technology Assessment and Forecast, “OTAF Custom Report, All Technologies Report, 1/1963-6/1983” (mimeo), 1983.
App. D—Patent Policy Regarding Medical Devices • 193

(see table D-1) are low, not because of a decrease in

technological activity, but because the Patent Office

issued fewer patents than normal because of a lack of

funds to print patents.

Table D-2, summarizing successful patent applications by the date of patent application, shows that U.S.

patents have remained at approximately 65,000 per

year through the 1970s (data for 1980 and subsequent

years are incomplete because of the delay between application and final ruling by the Patent and Trademark

Office). During this period, patents of foreign origin

increased from 30 to 40 percent of successful applications. About one-fourth of these patents of foreign

origin were Japanese, closely followed by patents from

West Germany (217).

Table D-3 summarizes 1981-83 data for selected indexes. In addition to the fact that about 40 percent of

patents were of foreign origin, more than 75 percent

were of corporate origin, about 2 percent were U.S.

or foreign-government owned, and about 7 percent

were owned by a foreign-resident inventor but assigned to a U.S. organization.

A patent can be sold (assigned), or it can be licensed

on an exclusive or nonexclusive basis. An exclusive

licensee has the right to enforce the patent. Nonexclusive licenses, granted to more than one party, are

simply promises that licensees will not be sued for patent infringement. Payment for a license is usually by

fee (e.g., $10,000 per year) or by royalty, based on

some measure of income such as frequency of use of

the invention or percent of sales of the invention (or

products incorporating it).

Patent owners police their own patents. If they

believe that their patents are being infringed, they may

let unauthorized uses continue and try to collect licensing fees from the unauthorized users. But if the

users refuse to cooperate, patent owners must go to

court to obtain an injunction against the unauthorized

use and to collect damages. .

Table D-3.–Data on Patent Approvals, Selected

Indexes, 1981-83a

Percent corporate-owned . . . . . . . . . . . . . . . . . . . . . 76.87%

Percent government-owned . . . . . . . . . . . . . . . . . . . 2.37%

Percent foreign-origin . . . . . . . . . . . . . . . . . . . . .. ..41.06%

Percent U.S.-owned of foreign . . . . . . . . . . . . . . . . . 7.170/0

aDeflnitlOnS: Paroont corporate-owned: 1981-83 U.S. patents assigned tO cOrPOrtaiona/lWl-83 patents x 100. Percent govommont.owned: 1981%3 U.S. patents

assigned to the U.S. or foreign governments/1981-83 patents x 100. Percent

tomfgn-ortgln: 1981-83 U.S. patents with foreign resident inventor/1981-83 patents

x 100. P.rc.nt U.S..owned of foreign: 1981-83 U.S. patents with a foreign resident inventor that are assigned to a U.S. organization11981 -83 patents with a

foreign resident inventor x 100.

SOURCE: U.S. Department of Commerce, Patent and Trademark Office, Office

of Technology Assessment and Forecast, “OTAF Custom Report, All

Technologies Report, January 1983 to June 1983 (mimeo), 1983.

The U.S. patent system is currently undergoing major changes. In July 1981, reexamination proceedings

were initiated under which anyone can request that

a patent be reexamined (accompanied by a $1,500 fee).

The Patent and Trademark Office can refuse to reexamine on the basis that no substantially new question was raised. In the same law (Public Law 96-517)

that authorized reexamination (in which other parties

can challenge a patent), Congress also required the Patent and Trademark Office to submit a plan to Congress by December 1982 on modernizing its files.

Patent protection is intended to stimulate invention

by giving potential inventors the exclusive right to any

benefits for a substantial time. A patent is also granted

as a reward for the early disclosure of the invention

to the public and not as a reward for either its discovery or for investment in its commercial development

and exploitation. If the public would benefit eventually

from the invention through its public disclosure or

commercial use, no reward would be necessary and

no patent would be given (101). This is the reason for

the patenting requirements of novelty and not being

obvious to someone working in the same field, and

for the requirement that the patent application must

contain enough information so that someone else can

copy it.

Some International Aspects of Patents

Only some of the international aspects of patents

are discussed here. One example of differences between

the United States and other countries in the area of

patent law is the concept of “prior art.” In the United

States, there is a l-year grace period between publishing of the invention (e.g., of a new technique in a professional journal) and filing for a patent. Most universities routinely require researchers to report promptly

inventions with potential commercialization so that the

university can assess their potential and file for a patent. Most other countries do not have such a grace

period.

Another example is that under current U.S. patent

law, it is legal to import a product made in another

country by a process covered by a U.S. patent without permission of the patent holder. A proposal to

make this an infringement of the U.S. patent was

reportedly part of the Patent and Trademark Office’s

1983 legislative proposals (220).

Under the Paris Convention of 1883, patent holders

are given a commercial monopoly (subject to certain

conditions) for their inventions in 92 signatory countries. Patent holders must publish details of their

discoveries in the signatory countries for other scientists to study, but the invention may not be copied for
194 ● Federal Policies and the Medical Devices Industry

profit. Member countries may allow rival manufacturers to produce the invention if patent holders abuse

their monopoly, for example, by neglecting to produce

the invention in the affected countries.

The Paris Convention is administered by the United

Nations’ World Intellectual Property Organization. In

the third conference on revisions of the Paris Convention for the Protection of Industrial Property, held in

Geneva in October 1982, the main issue was a proposal that would make it easier for developing countries

to confiscate and manufacture patented inventions.

Third-world governments had wanted a provision

giving them the right to take over and manufacture

on an exclusive basis any potential invention if the

original patent holder did not produce it in their country within 30 months of receiving a patent. The intent

was to force foreign manufacturers to produce their

inventions in the developing country instead of producing them elsewhere and importing them. Thirdworld countries claimed that large companies that hold

most patents can use imports to undercut a local manufacturer allowed to use their technology, so an exclusive license barring even the original patent holder

was necessary for local production. The proposal

would also have allowed a registered patent to be confiscated altogether after 5 years.

The developed countries opposed the proposal as

an expropriation of private property and because large

companies would become more secretive about their

inventions and reluctant to invest in developing countries. Chemical and pharmaceutical companies were

thought to be most vulnerable, because their patented

products are relatively easy to make once their formulas are known.

Prior to the October 1982 conference, Japan and the

West European countries had agreed to the proposal,

arguing that developing countries would find a way

to do it anyway, and that defining the conditions under

which exclusive licenses were granted would give

more, not less, protection. At the conference, the

United States offered a compromise proposal that

would grant nonexclusive licenses, but no agreement

was reached (194).

Patents and New Product Development

The value of patents in the decision to undertake

innovative activities depends on the type of invention

and on the type of decisionmaker. For example, the

pharmaceutical industry rarely pursues the development and regulatory approval processes for a new drug

unless it can be patented. Also, recall that drugs and

other chemicals, once identified, are relatively easy to

copy. In the 97th Congress, extension of the patent

term to recover time lost to the regulatory approval

process was the Pharmaceutical Manufacturers Association’s number one legislative priority, but it lost narrowly in the supplemental session of Congress. In contrast, much of the innovation in the electronics industry

has occurred without patents.

The importance of patents to small businesses is also

variable. Many small firms depend on trade secrets

rather than on patents. Reasons include the expense

of obtaining or having to defend patents, and the

uncertain outcome if the patent is challenged (234).

But the smaller of the small firms usually consider

patents to be more critical than do large businesses.

There are anecdotes of the importance of patents in

securing financial support. In interviews conducted for

another OTA study (347), eight venture capitalists distinguished between two types of investments: 1) those

that rely on a firm’s management team and rapid advances in technology to provide protection from competition, with the emphasis on short-term payouts on

the investments; and 2) technologies that require a long

research and development period, for which patents

become almost a prerequisite for investment.

In essence, the confidence that is placed in patents

is a key to determining the incentives for innovation

provided by patents. Little is statistically known about

these factors, but it appears that the degree of confidence varies over a wide range.

For products that require large capital costs, such

as automobile manufacturing, patents may have little

bearing on investment decisions because of the limited

ability of a competitor to enter the market. But patents

have another use for both large and small firms—

defensive use to prevent others from stopping the

patent holder in proceeding with his or her invention.

One example is in the development of the computed

tomography (CT) scanner (258):

Before CT, few X-ray companies bothered with patents, since all the X-ray companies recognized that no

one company had a monopoly on the patents, each

would have had to license from the other to stay in

business—the result being “why bother with patents?”

EMI, who was new to the X-ray business, heavily

patented their CT designs, and by the end of the decade was requiring substantial royalties from all the CT

suppliers. As a defensive measure, the X-ray companies substantially had to change their patent practices; for example, we [General Electric] went from

having the part-time use of one patent attorney to having three full-time patent attorneys. This, I believe,

was totally the result of EMI’s changing the practice

of an industry.
App. D—Patent Policy Regarding Medical Devices . 195

Patenting of Medical Devices

The U.S. Patent and Trademark Office classifies

patents into 400 to 500 functional categories, and no

specific category encompasses all medical devices. The

Food and Drug Administration’s (FDA) Office of Economic Analysis decided which categories should be

considered medical devices, and further categorized

these devices as either “low” or “high” technology,

depending on how “sophisticated” the device was

(390).

Table D-4 identifies which types of medical devices

have been categorized by FDA’s Office of Economic

Analysis as low or high technology and their patent

categories and subcategories as classified according to

the Patent and Trademark Office. Figures 2 and 3 in

chapter 5 summarize U.S. and foreign medical device

patents for these low- and high-technology medical

devices by application date for 1968 to 1979. Low technology patents increased in the early 1970s from about

800 per year to a peak during 1973 to 1974 of between

1,200 to 1,300 per year and remained at that general

level for the rest of the 1970s. Patents for high-technology medical devices, on the other hand, continued

to increase throughout the 1970s, doubling from more

than 500 per year in 1970 to more than 1,000 per year

by 1979.

In sum, in the 1970s: 1) there was a modest increase

in the annual number of successful patents for medical devices, while there was essentially no increase in

annual total patents granted; 2) patents for low-technology medical devices increased in the early 1970s but

remained essentially constant for the rest of the decade, while patents for high-technology medical devices

continued to increase throughout the decade; and 3)

while the percent of foreign-origin patents increased

for both medical devices and all inventions by approximately 10 percent, the percent of foreign-origin medical device patents (30 percent) was still lower than the

percent for all patents (40 percent) by the end of the

1970s.

Table D-4.–High- and Low-Technoiogy

Medical Devices as Classified by FDA’s

Office of Economic Analysis

High-technobgy devices:

A. Diagnostic equipment

1. Cardiac devices (128) 695-715a

2. Vascular devices (128) 669-694

3. Respiratory devices (128) 716-730

4. Stimulators, neurological, etc. (128) 731-746, 639-644

5. Radiation (128) 653-667

6. Other (128) 630-782, minus above codes plus 3-23

B. Respiratory methods

1. Mixing (128) 203.12-204.14

2. Supply (128) 204.18-205.26 plus 207.14-207.18

3. Substance removal (128) 205.27-207.13

4. Other (128) 200.11-200.23 and 204.15-204.17

C. Electrical systems and energy applicators (128)

419 R-804

D. Implantable artificial body members

1. Cardiovascular (3) 1.4-1.7

2. Legs, arms, bones, etc. (3) 1.913-2

3. Other (3) 1-1.2 and 13-36

E. Dialysis and blood filters (210) 321A-3216 and (422)

44-48

F. Miscellaneous (includes incubators, hearing aids,

magnetic devices) (128) 1R-1.5 and (181) 126-137

Low-technology devices:

A.

::

D.

E.

F.

Kinesitherapy (128) 24R-67

Orthopedic (128) 68-80J, 81 A-81R, 581-623

Bandages and trusses (128) 82-171

Mediators (604) 1-7, 11-19, 23-42, 46-72, 77-93,

104-170, 173-238, 239-263, 272-279, 285-302, 303-311,

403-416, 890-897

Instruments (604) 8-10, 43-45, 94-103, 171-172,

264-271, 280-284

Dental

1. Orthodontics (433) 2-24

2. Apparatus (433) 25-166

3. Prosthodontics (433) 167-214

G Ophthalmic

1. Examining equipment (351) 1-40

2. Frames (351) 41-158

3. Lenses (351) 159-177

H Miscellaneous (includes receptors, baths, canes) (604)

20-22, 73-76, 312-377, 378-402, (128) 362-403 — aNumbers refer to categories (in parentheses) and subcategories according to

the Manual of Classification, U.S. Department of Commerce, Patent and Trademark Office

SC)URCE US. Department of !-lealth and Human Services! Food and Drug Admin- i stration? Office Of Economic Analysis, Rockvllle, MD, personal com- municatlm, I)mernber 1963.
Appendix E.—Method Used for OTA’s Analysis of

Applications to the National Institutes of Health

for Small Business Innovation Research Grants

The data in table 31 (see ch. 4) are the result of an

OTA analysis of the Small Business Innovation Research (SBIR) grant applications submitted to the National Institutes of Health (NIH) for funding in October 1983. OTA obtained copies of all applications

submitted to NIH. A 50-percent-interval sample of applications (one of every two) was selected for analysis. (The total sample of 297 was selected from the 593

applications submitted. )

Using the Food and Drug Administration’s definition of a medical device, OTA divided the NIH SBIR

grant applications into three categories:

• biotechnology applications (includes medical device and other applications involving biotechnology),

• medical device applications (includes medical device applications not using biotechnology), and

• all other applications.

An application was categorized as a biotechnology application if the proposed research and development involved the use of recombinant DNA or other recently

developed genetic, cell fusion, or bioprocessing techniques. An application was classified as a medical device application if, first, it did not use biotechnology

and, second, it involved either research leading to the

actual development of a medical device or research

into techniques or products that would subsequently

be used in the development of a medical device (i.e.,

the development of new materials for use in a medical device).

Because judgment was involved in categorizing the

applications, inter-rater reliability was tested by having an independent rater analyze 36 randomly selected

applications from the sample (approximately 10 percent of the sample). The two independent raters agreed

on 26 out of the 36 applications (72 percent). This is

significantly higher than the level that would be expected by chance, but nevertheless allows a substantial level of variation.
Appendix F.—The Database of Venture Economics, Inc.,

on Sources of Financial Capital

Venture Economics, Inc., the research and consulting division of Capital Publishing Corp., maintains

an extensive database of information on the U.S. venture capital industry. The Venture Economics database

currently tracks investments by the leading venture

capital firms, both independent private and corporate

groups, which account for more than 80 percent of the

U.S. venture capital industry’s total investment activity. In addition, the database covers the investment

activities of Small Business Investment Corporations

(SBICs) involved in classic venture capital type investments. The database does include a small degree

of investment by foreign sources in U.S. companies

as well as investment from unidentified sources, some

of which may be non-venture-capital institutional

funding.

Through extensive data collection efforts, Venture

Economics has been able to research and computerize

information on more than 4,300 companies that have

received venture capital financing since the 1960s. Efforts to date have focused on the computerization of

the following information on each portfolio company:

●

●

●

●

●

●

company name and address, -

business description,

industry or business codes including the Standard Industrial Classification code and more specific codes developed by Venture Economics,

status of the firm (public or private),

year founded, and

for each round of financing:

— amount of financing,

— date of the financing round,

— stage of development of the company, and

— venture capital investors.

Table 30 in chapter 4, which listed the percentage

of U.S. venture capital funds invested in medical imaging, other medical products, industrial products, and

electronics, was based on the Venture Economics

database’s recorded venture capital investments for

1982. Although the investments recorded by the Venture Economics database do not account for all venture capital investments (see table F-l), in aggregate,

they do offer a representative picture of venture capital investment activity. The categories of investors covered by the database are presented in table F-2. Medical imaging and the three other industry/product

categories mentioned above, which were used in table

30 to classify firms receiving venture capital funds, are

shown in table F-3. Definitions of the stages of financing used to categorize financing rounds in table 30 are

shown in table F-4.

Table F.I.—Total Investments by the U.S. Venture

Capital Industry, 1978-82 (millions of dollars)

——

Investments

Total venture recorded by the

capital Venture Economics

Year investments database

1978 . . . . . . . . . . . . $ 550 $ 282

1979 . . . . . . . . . . . . 1,000 500

1980 . . . . . . . . . . . . 1,100 803

1981 . . . . . . . . . . . 1,400 1,400

1982 . . . . . . . . . . . . . 1.800 1,760

SOURCE: Venture Economics, Wellesley Hills, MA, “Venture Capital Investment in

the Medical Health Care Field;’ contract report prepared for the Office

of Technology Assessment, August 1983,

Table F-2.–Categories of Investor Types Covered by

the Venture Economics Databasea

Independent private (225 investors):

Independent private funds

SBIC subsidiaries of private funds

Corporate financial (120 investors):

SBIC and non-SBIC subsidiaries of financial groups

Other investments by financial groups including insurance

companies

Corporate industrial (125 investors):

Venture capital funds wholly or jointly funded by

nonfinancial corporations

Direct corporate venture capital investors

SBIC subsidiaries of these industrial corporations

Nonaffiliated SBICs (140 investors):

Public and private SBICs not affiliated with any of the

above investor types

Other (240 investors):b

Government affiliated groups

Community development corporations

Universities

Individuals

—Foreign investors

a

The number of investors in each category includes investment groups that are no

longer actwe or that make only occasional investments.

bThe majority of these are United Kingdom funds that do not iflvest in the United

States on a regular basis.

SOURCE Venture Economics, Wellesley Hills, MA, “Venture Capital Investment In

the Medical Health Care Field;’ contract report prepared for the Office

~’ Technology Assessment, August 1983.

197
Table F-3.—Four Product Categories Used in the

Venture Economics Database

Medical imaging:

X-rays

CT scanning

Ultrasound imaging

Nuclear imaging

Other imaging

Medical products and services:

Diagnostic (not including medical imaging):

Diagnostic services

Diagnostic test products and equipment

Other diagnostic

Therapeutic:

Therapeutic services

Surgical instruments and equipment

Pacemakers and artificial organs

Drug delivery and other therapeutic equipment

Other therapeutic including defibrillator

Other medical or health related:

Disposable products

Handicap aids

Monitoring equipment

Other medical or health related (not including pharmaceuticals, fine chemicals, or hospital and other institutional

management including management services and

leasing)

Industrial products:

Advanced materials (including production processes)

Industrial automation

Industrial equipment and machinery

Chemicals

Pollution and recycling equipment

Other industrial products

Other electronics industry segments:

Electronic components:

Semiconductors

Microprocessors

Controllers

Circuit boards

Display panels

Other electronic components

Batteries

Power supplies

Electronics-related equipment:

Semiconductor fabrication equipment and wafer products

Component testing equipment

Other electronics-related equipment

Laser related

Fiber optics

Analytical and scientific instrumentation:

Chromatography and related laboratory instrumentation

(including spectrometers)

Other measuring devices (including infrared gas analyzers,

moisture analyzers)

Other analytical and scientific instrumentation

Other electronics-related equipment:

Military electronics (excluding communications)

Copiers

Calculators

Other electronics related

SOURCE: Venture Economics, Welieeley Hiils, MA, “Venture Capital Investment

in the Medical Health Care Field,” contract report prepared for the

Office of Technology Assessment, August 19S3.

Table F-4.-Definitions of Stages of Venture

Capital Financing

Early stage:

Seed—A relatively small amount of capital provided to an

inventor or entrepreneur to prove a concept. It may involve

product development but rarely involves initial marketing.

Startup-Financing provided to companies for use in product

development and initial marketing. Companies may be in the

process of being organized or have been in business a short

time (1 year or less), but have not sold their product

commercially. Generally such firms would have assembled

the key management, prepared a business plan, and made

market studies.

First stage—Financing provided to companies that have

expended their initial capital (often in developing a prototype)

and require funds to initiate commercial manufacturing and

sales.

Expansion:

Second stage—Working capital for the initial expansion of a

company which is producing and shipping and has growing

accounts receivable and inventories. Although the company

has clearly made progress it may not yet be showing a profit.

Third stage—Funds provided for the major growth expansion

of a company whose sales volume is increasing and which

is breaking even or profitable. These funds are utilized for

further plant expansion, marketing, and working capital or

development of an improved product.

Fourth stage—The last round of private financing prior to, but

not in anticipation of, a public offering or prior to the point

at which a company can qualify for credit-oriented institutional

term financing. This round may enable institutional term

financing or may involve turnaround aspects.

Bridge financing— Financing for a company expecting to go

public within 6 months to a year. Often bridge financing is

so structured that it can be repaid from proceeds of a public

underwriting. It can also involve restructuring of major

stockholder positions through secondary transactions. This

would be done if there were early investors who wanted to

reduce or liquidate their positions, or if management had

changed and the stockholdings of former management, their

relatives and associates, were to be bought out to relieve

potential overhead stock supply when public.

Leveraged buyouts and acquisition:

Acquisition for expansion—Funds provided to a firm to finance

its acquisition of another company.

Management/leveraged buyout—Funds provided to enable

operating management to acquire a product line or business

(which may be at any stage of development) from either a

public company or private company (often such companies

are either closely held or family-owned). This usually involves

revitalization of the operation, with entrepreneurial

management acquiring a significant equity interest.

other

Turnaround—Financing provided to a company at a time of

operational or financial difficulty with the intention of “turning

around” or improving the company’s performance.

Secondary purchase—Purchase of securities from another

venture capital firm, other stockholders, or on the open

market.

SOURCE” Venture Economics, Wellesiey Hiils, MA, “Venture Capital Investment

in the Medical Health Care Field, ” contract report prepared for the

Office of Technology Assessment, August 19S3.
Appendix G. —Tax Policy and Research and Development

on Medical Devices1

Introduction

Much attention has been paid to potential effects of

tax policy on incentives for innovation. Renewed interest in this question has recently been prompted by

enactment of the Economic Recovery Tax Act of 1981

(ERTA) and the Tax Equity and Fiscal Responsibility

Act of 1982 (TEFRA). As a result of both ERTA and

TEFRA, basic changes were made in both the personal

and the corporate income tax including: 1) changes in

marginal tax rates on personal income, 2) changes in

the tax rules for depreciation of capital goods, and 3)

enactment of new provisions applying to research and

development (R&D).

Assessing the impact of these tax changes on the financial incentives for innovation generally, let alone

innovation in medical devices, is extremely complex.

However, it is possible to identify two distinct ways

in which tax policy changes such as ERTA and TEFRA

can affect incentives for innovation. First, tax incentives may alter the expected after-tax returns received

by prospective purchasers of goods that embody innovations, thereby stimulating, or inducing, the demand for such innovations. Second, both personal and

corporate income taxes will cause after-tax prices in

capital markets to diverge from pre-tax prices. Both

the size of this divergence and its pattern among different types of investments may influence the willingness of firms and individuals to invest in R&D and

innovation.

Taxes and Induced Innovation

There is some evidence that the level of innovative

activity in the development of particular goods is

related to the overall level of demand for those goods.

A particularly important example of such induced innovation is the case of capital goods innovation, where

several empirical studies have shown that the level of

capital spending by industry affects the level of innovation in capital goods (273, 276). Because ERTA/TEFRA

permit firms to deduct the costs of depreciable assets

more rapidly than was previously allowed, these tax

policy changes are expected to stimulate greater capital spending by industry. According to the inducedinnovation hypothesis, such increased capital spending

should also stimulate innovative activity among those

firms producing capital goods.

1This appendix was written for OTA by Barth and Cordes (27).

Many medical devices are clearly capital goods.

However, the market for medical devices differs from

the market for other capital goods in one important

respect. Because many of the purchasers of medical

devices are not subject to taxation, their demands for

medical devices should not be directly affected by tax

rules governing depreciation of capital goods. Thus,

the tax provisions of ERTA/TEFRA may be expected

to have a smaller impact on the capital spending decisions of purchasers of medical devices than of purchasers of other capital goods.

This situation implies that any induced innovation

attributable to ERTA/TEFRA will also be less in the

case of medical devices than other capital goods. Of

course, TEFRA contained a section specific to Medicare payment of hospitals, which, with its subsequent

modifications under the Social Security Amendments

of 1983 (Public Law 98-21), dramatically altered the

incentives of hospitals to purchase medical technology

(see ch. 3 for details).

Another, perhaps more important, way in which the

tax code can affect the demand for medical devices is

through the tax treatment of employer-paid health

benefits. Because such benefits are typically treated as

nontaxable fringe benefits, employees, particularly

those facing high marginal tax rates, have a tax incentive to receive part of their labor compensation in the

form of such benefits. The growth of health benefit

plans has been one of a number of factors contributing to growth in demand for health services during the

postwar period, and this growth in demand may also

have encouraged innovations in medical devices.

Although the tax-exempt status of fringe benefits has

not been affected by ERTA/TEFRA, there has been

some support for changes in tax law which would limit

the tax exemption currently enjoyed by all fringe

benefits, included employer-paid health benefits. If

these changes were enacted, it is likely that both the

level and composition of demand for health services

would be affected, and this change in turn could have

some impact on the level and type of R&D in the medical devices industry.

Taxes and Suppliers of Innovation

The ultimate suppliers of innovations are the individuals or firms who choose to allocate resources to

R&D rather than to other investment projects. In part,

such choices are made outside the boundaries of the

firm in external capital markets by individual investors

who must decide how to allocate their portfolios of

199
200 • Federal Policies and the Medical Devices Industry

wealth among different investments. In part, such

choices are made within the firms by managers who

must choose among competing uses of a firm’s capital

budget. In both cases, however, the tax treatment of

different investment options is an important factor in

the ultimate investment decision.

Two alternative investments may be equally productive before the income from such investments is

taxed and yet earn different after-tax returns if one investment is taxed relatively more heavily than the

other. In such an event, two investments which are

equally attractive insofar as social returns are concerned are not equal in the eye of the prospective investor, who will choose the investment with the higher

after-tax return.

In the case of R&D investments, there are two principal ways in which the tax code affects their aftertax return compared to other investment activities. The

first is the tax treatment of capital gains. The second

is the tax treatment of inputs specific to the innovation process.

Taxation of Capital Gains

The expected returns on an investment may be

realized through annual flows of income, through capital gains or losses resulting from changes in the asset

price of the investment, or through some combination

of annual flows and changes in asset values. In the

absence of taxation, the manner in which the return

was expected to be received would be irrelevant to the

ultimate investment decision. All that would matter

would be the total expected return (annual expected

flows plus or minus capital gains and losses) and the

expected risk (the variance of realized returns around

the total expected return). However, because capital

gains and capital losses are treated differently from

income under U.S. income tax, investments whose

returns are realized primarily through capital gains or

capital losses will be evaluated on a different after-tax

basis from investments whose returns are realized

through annual flows of ordinary income.

At present, capital gains are not taxed until they are

actually realized into cash through sale of the asset.

More importantly, if the asset is held for longer than

1 year, the capital gain that is realized is taxed at a

rate which is generally 40 percent of the tax rate applied to ordinary income. Thus, for example, if a person’s tax rate on ordinary income were the maximum

rate of 50 percent, the tax rate applied to each dollar

of long-term capital gain would be 20 percent. If the

investment should prove unsuccessful, and a capital

loss is realized, the loss maybe offset dollar for dollar

against capital gains. However, if reported capital

losses are greater than the capital gains, the net capital loss may be only partially applied as a deduction

against ordinary income.

In effect, the U.S. tax system provides preferential

treatment to investments which pay off in the form

of capital gains, while providing less than complete

tax offsets to investments which result in capital losses.

Assessing the impact of such a system on the propensity of investors to take risk—and by implication to

invest in innovative activities—is an extremely complex task, and the conclusions that emerge from such

an assessment depend on the standard used for comparison.

If the alternative is a tax system which taxed capital gains in full but also allowed full and complete

deductibility of capital losses, it would be impossible

to ascertain on theoretical grounds which of the two

tax regimes—the current one, or the alternative-is the

most favorable to risk-taking because the differences

would work in opposite directions. However, compared with an alternative system which taxed capital

gains the same as ordinary income but continued to

allow only partial tax offsets for capital losses, preferential tax treatment of capital gains encourages more

risk-taking. That is, given that loss offsets are incomplete, partial rather than full taxation of capital gains

may be one way of preserving incentives for risktaking.

Two groups of individuals for whom the tax treatment of capital gains would appear to be particularly

important are the entrepreneur-founders of new ventures and the venture capitalists who provide external financing to such ventures. Those who choose to

become entrepreneurs have in effect chosen to forgo

relatively certain returns to their human capital (i. e.,

labor) which could be earned from salaried employment, as well as returns to any personal financial capital they invest, in order to develop an idea or invention into a new product or service.

Presumably, this decision is motivated by a variety

of considerations and is certainly not limited to tax

factors. However, the fact that the expected returns

to entrepreneurship will typically be realized in the

form of increases in the value of the entrepreneur’s

ownership share in the firm, which in turn will be taxed

favorably as capital gains, would at the margin encourage rather than discourage entrepreneurship. Indeed, there is some empirical evidence that the preferential tax treatment of capital gains has influenced

the decision of individuals ’between salaried employment and entrepreneurship (151).

Similar considerations apply to individual venture

capitalists. Although such persons are not themselves

actively engaged in the development of innovations,
App. G—Tax Policy and Research and Development on Medical Devices ● 201

they typically share in both the risks and rewards of

entrepreneurship through equity participation in the

entrepreneurial firm. The fact that any returns to such

participation are likely to be realized through appreciation in stock values, and therefore to be taxed favorably as capital gains, would, at the margin, encourage the commitment of venture capital.

Data provided to OTA on the organized venture

capital market suggest that venture capitalists are more

likely to commit funds to the early stages of firm development in the case of medically oriented ventures

than they are in the case of other industrial ventures

(see table 30 in ch. 4). The data also show that capital

provided to medical device ventures is more likely to

come from private, independent sources than from

corporations or small business investment companies

(443). These two considerations imply that individual

tax incentives which encourage the commitment of risk

capital may be of special importance to innovation in

medical devices.

Finally, the current tax treatment of capital gains

interacts with the double-taxation of dividends at the

corporate level to encourage earnings retention rather

than dividend payout. If earnings are paid out in

dividends, such income will be taxed in full at ordinary

income tax rates. However, if the earnings are retained

and reinvested, stockholders can defer paying personal

taxes until any expected capital gains are realized

through sale of stock, and then do so at preferential

capital gains tax rates. As a result, the effective tax

on income from corporate equity is less under earnings retention than under dividend payout. At the

margin, this encourages firms to retain earnings and,

if retained earnings are an important source of funds

for some innovations, enhances the financial resources

available for innovative activities.

The current tax treatment of capital gains would appear to provide benefits to investments in medical device innovations which are equal to those provided to

other risky investments, However, the overall value

of the tax preference on capital gains to the highest

income investors has been somewhat reduced by ERTA,

which lowered the maximum tax rate on “unearned

income” from 70 to 50 percent.

Corporate Tax Policy

In the case of relatively established firms, the decision to engage in R&D requires that resources be used

to develop and produce a new product which could

instead be used to enhance the firm’s ability to produce its existing products. If the firm’s ultimate objective is to maximize its value, this implies that capital

should be allocated to R&D up to the point where the

last dollar allocated earns a risk-adjusted expected

after-tax return equal to that earned from a dollar invested in a more traditional investment activity.

If the tax code is neutral in its treatment of the productive inputs used in different investment projects,

tax considerations will not influence the firm’s allocation of capital among competing investment activities.

However, if the tax code favors the use of certain inputs, and if these favored inputs are specific to certain types of investment projects, tax considerations

will affect the amount of capital allocated to different

projects. In effect, investments that use tax-favored inputs will be encouraged, because they will need to earn

a lower pre-tax return in order to earn a given aftertax return than will investments that do not use taxfavored inputs.

Tax Treatment Before and After ERTA/TEFRA.–

In the case of R&D, the issue is whether the inputs used

for R&D are treated more or less favorably than inputs used in other investment activities. The two principal inputs needed to develop innovations are tangible capital in the form of depreciable assets and intangible

capital arising from expenditures on R&D.

Prior to the enactment of ERTA/TEFRA, tangible

capital used in conducting R&D was treated the same

as tangible capital used for other purposes. Firms using

such capital were entitled to claim an investment tax

credit on new equipment, but not structures, and could

then claim a stream of depreciation deductions over

a number of years based on guidelines established by

the Department of Treasury. However, neither the

amount of the investment credit nor the speed at which

the asset could be depreciated were related to the type

of investment project in which the asset was used—

i.e., to whether the asset was used in R&D or in a more

traditional investment activity.

Other costs of R&D were, however, given special

treatment. Specifically, section 174 of the Internal Revenue Service Code allowed the salaries and expenses

incurred to develop R&D to be deducted immediately

in the year incurred. This “expensing” of R&D was

viewed as preferential treatment because R&D salaries and expenses were seen as part of the costs of acquiring an intangible asset which was capable of providing services to the firm over a number of years.

Under this view, expensing confers favorable tax treatment on R&D activities.

Enactment of ERTA/TEFRA has altered the relative

position of different kinds of investments in three

ways. First, though the rules governing R&D expensing were not changed by ERTA/TEFRA, the rules

governing depreciation of other capital assets have

been liberalized considerably by adoption of the Accelerated Cost Recovery System (ACRS). Second, for

the first time, tax depreciation rules treat equipment

used in R&D as different from equipment used in other

25-406 0 - 84 - 14
202 ● Federal Policies and the Medical Devices Industry

activities. Third, for the first time, R&D outlays which

qualify for expensing may also qualify for a tax credit.

In the remainder of this section, we examine how these

measures-both singly and in combination-affect the

relative attractiveness of innovative investments generally, and innovation in medical devices specifically.

Accelerated cost recovery. ACRS, enacted as part

of ERTA with some modifications in TEFRA, speeds

up the rate at which the costs of using depreciable

assets may be recovered.

Depreciable capital assets (e.g., equipment and

buildings) are important inputs into R&D. However,

the capital intensity of R&D differs among projects so

that the impact of changes in cost recovery rules will

be greater for some types of R&D projects than for

others. Liberalized cost recovery favors R&D projects

that are relatively capital-intensive.

Detailed data on the capital intensity of R&D in different industries do not exist. However, National

Science Foundation (NSF) data can be used to construct a crude index of factor intensity in R&D: the

ratio of R&D expenditures to scientists and engineers

employed in R&D. Other things being equal, this ratio

should be higher in industries in which R&D is more

capital-intensive. Based on this ratio, one may therefore ascertain whether R&D activities in any given industry benefit relatively more or less from ACRS.

While NSF data do not permit the above ratio to

be calculated specifically for medical device producers,

the ratio can be calculated for producers of optical,

surgical, and photographic equipment (Standard Industrial Classification (SIC) codes 383-387). Between

1976 and 1979, the R&D capital-intensity ratio for this

industry group exceeded the average ratio for all manufacturing industries. This suggests that the R&D investments of medical device producers in these SIC

codes benefit relatively more from ACRS than do R&D

investments of other manufacturers.

The overall effect of the ACRS on R&Din medical

devices is unclear, however, because ACRS moves the

tax treatment of non-R&D capital closer to that of

R&D expensing. This reduces the relative attractiveness of using business funds for R&D expenditures that

qualify for expensing. While ACRS has a scale effect

favorable to all investment projects using depreciable

capital, it has a substitution effect which tends to favor capital investments that do not involve R&D (27).

That is, while ACRS reduces effective tax rates on all

investments, it reduces them more for investment projects which are relatively less intensive in the type of

R&D which qualifies for expensing. The net effect of

the two effects on R&D in medical devices is unknown.

Special treatment of R&D equipment, One provision of ACRS which applies specifically to depreciable

assets used in R&D is the assignment of all R&D equipment to the “3-year recovery class.” Because of this

provision, all equipment used in R&D must be depreciated over 3 years, even though the ACRS guidelines

would normally require that the same equipment be

depreciated over a longer period of time if used for

other purposes. Because non-R&D equipment is assigned to either the 5- or 10-year recovery class, this

provision would appear to favor R&D by allowing the

capital costs of equipment to be deducted more rapidly

if the equipment is used for R&D rather than in other

activities. However, while equipment used in R&D

may be written off more rapidly, all equipment in the

3-year recovery class qualifies for a smaller investment

tax credit—6 percent—than equipment in the longer

lived asset classes, which is eligible for a 10-percent

investment credit.

Under ERTA, the disadvantage of receiving a smaller

investment credit was large enough to offset the advantage of more rapid writeoff. However, because of

changes made in TEFRA which reduced the value of

the writeoff, this no longer appears to be the case.

Given the current set of tax rules, the net effect of

grouping R&D equipment into a special recovery class

is favorable to equipment used in R&D. (For a more

elaborate discussion, see Barth, Cordes, and Tassey,

1984 (27); Collins, 1983 (65); Zakupowsky and Sunley,

1982 (466).)

Tax credit for incremental R&D. As a result of

ERTA, firms can also claim a tax credit for certain

R&D spending. The amount of the credit equals 25 percent of the amount of which “qualified research expenses” during a year exceed the base period level of

such expenses. The base period level is the average

qualified expenses of the 3 preceding years, while

qualified expenses are those defined in keeping with

section 174 (the R&D expensing provision). If the firm

pays other parties to conduct R&D, 65 percent of such

purchases are deemed to be qualified research expenses.

The R&D credit is scheduled to expire as of January

1, 1986.

Predicting the impact of the existing R&D tax credit

is difficult for two reasons. First, the R&D credit is

temporary rather than permanent. Second, the amount

of the credit is based on incremental rather than total

expenditures. A detailed analysis of the effect of the

R&D credit is beyond the scope of this discussion (see

Barth, Cordes, and Tassey, 1984 (27) for a complete

treatment), but it is possible to make a rough assessment of the benefits which producers of medical devices have thus far derived from the R&D credit in

relation to firms in other industries.

In a preliminary sample of 1981 tax returns taken

by the Department of Treasury, producers of optical,
App. G—Tax Policy and Research and Development on Medical Devices ● 203

medical, and ophthalmic goods claimed R&D credits

equal to 5.4 percent of total eligible R&D spending,

while the corresponding figure for producers of other

electrical equipment, including manufacturers of electronic medical devices, was approximately 3.5 percent

(418). These percentages may be compared with the

percentage for all of the manufacturing firms sampled,

which was 4.8 percent.

Results reported by Eisner and colleagues for 1981,

based on data in the Compustat tapes, are qualitatively

consistent with these estimates. Specifically, Eisner and

colleagues calculate that firms in the NSF industry

group “optical, surgical, and other instruments” claimed

R&D tax credits equal to 4.6 percent of eligible R&D,

as compared with all manufacturing firms, which

claimed R&D credits equal to 3.3 percent of eligible

R&D (98a). However, their predictions for 1982 based

on simulations indicate that producers of optical, surgical, and other instruments would be eligible to claim

R&D credits equal to only 2.6 percent of qualifying

R&D, as compared with all manufacturing firms,

which would be able to claim credits equal to 2.8 percent of eligible R&D spending.

The differences reflect differences among the sampled firms in the rate of growth in eligible R&D. However, because the numbers pertain only to eligible

R&D, they provide but a partial view of the relative

impact of the R&D credit. The reason is that total R&D

spending consists both of outlays for eligible R&D and

outlays for R&D depreciable capital. Unfortunately,

because R&D depreciable capital does not qualify for

special tax treatment, firms are not required to report

this component of R&D in their tax returns. Hence,

it is difficult to estimate precisely the amount of R&D

claimed as a percent of all R&D.

A crude estimate of this latter magnitude may be

obtained as follows. In the case of all manufacturing

firms, it has been estimated that total company R&D

spending equals roughly 2 percent of sales (423). However, the total amount of eligible company R&D reported by manufacturing firms in the Treasury sample equals only about 0.66 percent of the receipts

reported by the firms (418). This figure suggests that

eligible R&D spending equals roughly 33 percent of

all R&D spending by firms in the sample. In this case,

the amount of R&D credits claimed as a percentage

of all R&D spending would be 1.6 percent (one-third

of 4.8 percent).

By comparison, NSF estimates that producers of optical, medical, and surgical instruments that perform

R&D spend amounts on R&D which equal roughly 5

percent of sales (423). The total amount of eligible

R&D reported by sampled producers of optical, medical, and ophthalmic goods equaled 0.8 percent of

reported receipts. Thus, eligible R&D equaled roughly

16 percent of all R&D spending by this group of firms,

so that the amount of R&D credits claimed as a percentage of all R&D would be 0.9 percent. With the

same procedure it is estimated that producers of other

electrical equipment (including medical electronic

devices) claimed credits equal to 0.5 percent of total

eligible R&D.

Thus, as a percentage total of R&D spending, the

amount of R&D credit claimed by medical device producers may be less than that claimed by all manufacturing firms. Of course, the industry classifications

make it difficult to generalize about medical devices

per se. The difference arises because eligible R&D may

be a smaller share of total R&D among medical device producers than it is among all manufacturing

firms.

Conclusion

The analysis above suggests that the current tax system is generally favorable to R&D investments, but

the incentives differ both among different types of innovation and among different phases of the innovation process. With respect to medical devices, the

limited data available suggest that R&D is relatively

capital-intensive. Consequently, medical device R&D

should benefit somewhat more than other industries’

R&D from the recent liberalization of tax depreciation

allowances. However, to the extent that the innovative

process in medical devices is more capital-intensive,

the incentive effects of the incremental tax credit for

R&D may be somewhat less for medical device producers than it is for firms whose R&D is more 1aborintensive, because the special tax treatment of R&D

does not apply to capital expenditures.
Appendix H.—Consensus Standards Related to

International Trade in Medical Devices1

Introduction

The ability to market medical devices effectively

outside the United States depends partly on regulatory

controls imposed by the U.S. and foreign governments

and on standards or specifications set by local, national, and international bodies. Most nations, including the United States, use regulations and product standards to control the sale of medical devices,

both foreign and domestic. Although the need to protect public health and safety provides justification for

governmental regulation, governmentally imposed requirements relating to standards, certifications, inspections and testing may create nontariff trade barriers.

Standards based on one nation’s technology may by

definition exclude foreign products. Testing and approval procedures, developed and required for domestic use, may be conducted in such a way as to inordinately increase importers’ expenses. The internal

orientation of certification systems may serve to limit

access for imports or deny certification to imported

products (379). These factors underscore the importance of international cooperation and coordination

in standards-related activities.

The General Agreement on Tariffs and Trade (GATT)

is the principal multilateral instrument that sets agreed

rules for international trade. Its basic aim is to liberalize world trading practices through reduction of

tariff and nontariff trade barriers. GATT, concluded

in 1948 and currently subscribed to by 87 nations, provides a continuing forum for multilateral discussions

and negotiations on trade matters. In contrast to earlier

rounds of negotiations which focused almost exclusively on tariff issues, the “Tokyo Round, ” completed

in 1979, focused on reducing or removing nontariff

barriers to trade and resulted in six major agreements

dealing with nontariff matters. One such agreement—

The Agreement on Technical Barriers to Trade (or

“Standards Code’’)—is of particular importance to

the medical devices industry and currently has more

signatories than any other GATT code (see table H1). The Standards Code establishes international principles governing the development, adoption, or application of any standard or certification system by

the signatories and thereby seeks to eliminate the use

of standards and certification systems as nontariff

trade barriers (379). Title IV of the Trade Agreements

Act of 1979 (19 U.S.C. § 2501 et seq. ) approved U.S.

acceptance of the Standards Code and served to implement the code in the United States.

1This appendix was drawn from a paper prepared for OTA by Lepon and

Gawron (193).

204

This appendix explores how established international trade agreements (such as GATT) and Federal

laws (such as the Trade Agreements Act) have affected

trade in medical devices, specifically as they relate to

the development and application of standards. This

appendix also describes organizations and agencies involved in medical device standards-setting procedures,

their procedures, the effect of implementing their

standards, and U.S. Government responsibilities in

standards-setting.

Standards-Setting Organizations

U.S. Voluntary Consensus Organizations

Standards for medical devices in the United States

have traditionally been developed in the private sector by professional organizations, trade associations,

and voluntary standards organizations. These voluntary consensus standards are nonbinding standards developed by consensus among voluntary participants

such as consumers, manufacturers, professional association representatives, physicians, clinical technicians,

hospitals, and other users (117). Besides the organizations described below, additional ones represent specific interest groups such as hospitals, hospital supTable H-1 .—Signatories to the Standards Codea

Argentina

Austria

Belgium b

Brazil

Canada

Chile

Czechoslovakia

Denmarkb

Egypt

European Economic

Community b

Finland

Franceb

Federal Republic of

Germany b

Greece c

Hungary

India

Irelandb

Italy b

Japan

Korea

Luxembourg b

Netherlands b

New Zealand

Norway

Pakistan

Philippines

Romania

Rwanda

Singapore

Spain

Sweden

Switzerland

Tunisia

United Kingdomb

Hong Kong

United States

Yugoslavia

a–As of N& 1, 1983.

b~he Standards Code is adhered to by the European Economic COmmunity, in

addition to being adhered to by the 10 member states of the community,

SOURCE U.S. Executive Office of the President, Office of the U.S. Trade

Representative, “Status of Tokyo Round MTN Agreement Signatures

and Acceptances, ” Nov. 1, 1983,
App. H—Consensus Standards Related to International Trade in Medical Devices . 205

pliers, health industry manufacturers, mechanical

engineers, dentists, and pathologists (see table H-2).

Some of these organizations develop standards for use

by their own membership or have representatives on

the boards and committees of other standards-setting

organizations.

American National Standards Institute, Inc. (ANSI).–

ANSI is a private, nonprofit federation of standardsdeveloping organizations and standards users. Founded

in 1918, ANSI has been established over the years as

the primary U.S. organization for sanctioning and approving voluntary standards in many fields. ANSI approves the American National Standards, a compilation of standards widely accepted by manufacturers,

product purchasers, and other professional organizations. ANSI has delegated the planning and coordination of standards in the medical device field to its

Medical Devices Standards Management Board, which

is composed of representatives from professional societies, trade associations, Government agencies, and

general interest groups.

Through this board, ANSI has approved nearly 200

standards for medical devices, primarily by accrediting

the standards developed by other organizations. These

standards include many for devices used for cardiovascular surgery, neurosurgery, ophthalmology, orthopedics, dentistry, anesthesiology, thoracic surgery,

respiratory assistance, and in vitro diagnostic prodTable H-2.-Additional U.S. Organizations Involved in

Voluntary Standards Setting for Medical Devices

American Academy of Allergy

American Association for Clinical Chemistry

American Association of Blood Banks

American Association of Immunologists

American Dental Association

American Heart Association

American Hospital Association

American Institute for Ultrasound in Medicine

American Psychiatric Association

American Society for Artificial Internal Organs, Inc.

American Society for Microbiology

American Society of Mechanical Engineers

American Thoracic Society

College of American Pathologists

Compressed Gas Association

Health Industry Manufacturers Association

Hearing Industries Association

Illuminating Engineering Society

Institute of Electrical and Electronics Engineers

National Council on Radiation Protection and Measurements

National Electrical Manufacturers Association

National Sanitation Foundation

Pharmaceutical Manufacturers Association

Scientific Apparatus Makers Association

SOURCE: J, Lepon and E. Gawron, Kornmeier, McCarthy, Lepon, and Harris,

“Medical Device Standards and International Trade,” contract report

prepared for the Office of Technology Assessment, 1983.

ucts. ANSI also represents the United States in international standards-setting bodies, most notably the International Electrotechnical Commission (IEC).

ANSI coordinates standards to eliminate duplication among those developed by different organizations. In addition, it serves as a clearinghouse to provide standards developers with information on the

procedures and activities of other standards developers.

Before a standard can receive the American National

Standards designation, it must be reviewed by ANSI’s

appropriate committees. To this end, ANSI solicits

comments from interested parties on the proposed

standard in an effort to ensure that its due process requirements are met. If, as is sometimes the case, other

recognized national standards already exist, ANSI will

work to harmonize the standards so as to eliminate

any overlap in content and ensure that a voluntary

consensus can be achieved among the affected organizations.

Association for the Advancement of Medical Instrumentation (AAMI).—AAMI is a nonprofit, professional association formed in 1967 and comprised of

individuals, hospitals, health care facilities, professional and medical societies, Government agencies,

manufacturers, and research and educational institutions concerned with the development, evaluation, and

application of medical devices. Approximately 40 medical device standards, process guidelines, and recommended practices concerning such areas as critical care

instrumentation are currently under development, and

11 are available in final form. AAMI carries out its

work through technical committees composed of both

medical device manufacturers and medical device users

in an attempt to balance representation by the groups

which will potentially be affected by any approved

standards.

AAMI participates in the international standardssetting activities of organizations like the International

Organization for Standardization (ISO) and IEC through

its membership in ANSI. At the request of ISO and

IEC, AAMI has placed its members on their technical

committees. For instance, an AAMI participant sits on

ISO’s technical subcommittee for cardiovascular implants and represents the view of AAMI members.

American Society for Testing and Materials (ASTM).

—ASTM, founded in 1898, is a nonprofit, nongovernmental organization involved in developing voluntary

consensus standards. In medical devices, its standards

primarily, but not exclusively, relate to materials used

to manufacture devices. ASTM has over 30,000 individual members representing Government agencies,

private physicians, hospitals, public and private laboratories, and medical device manufacturers. ASTM

standards provide guidance in determining the biocompatibility of materials; define the properties and char-
206 • Federal Policies and the Medical Devices Industry

acteristics of such materials as plastics, metals, and

ceramics; and establish testing methods and recommended handling practices for medical and surgical instruments. Nearly 30 technical committees are involved

in reviewing and developing standards for medical surgical materials and devices.

National Fire Protection Association (NFPA).–

NFPA is an independent, voluntary, nonprofit organization established in 1896 to protect people and their

environment from destructive fires. NFPA’s membership is comprised of interested individuals and representatives of national trade and professional organizations. A primary function is the development of

safety standards and codes that eventually become part

of the National Fire Codes, a multivolume set of final,

approved NFPA standards.

In 1975, NFPA established a health care section to

assist in the development of standards that may help

to prevent fires in medical facilities. NFPA also encourages safe use of medical devices, particularly electrically powered medical devices, in patient areas. It

participates in many other standards-setting organizations by placing its members or organizational staff

on their technical committees. For instance, NFPA is

an active participant on ASTM’s committee on the

hazard potential of chemicals and ASTM’s subcommittee on flammability and ignition testing, AAMI’s

subcommittees on electrical safety and monitoring

devices, and the U.S. Veterans Administration (VA)

Advisory Committee on structural safety of VA facilities. Through its membership in ANSI, NFPA also

assists in the review and development of the American National Standards and participates in the international standards development activities of IEC.

NFPA standards for safety have been widely accepted by States and local governments in establishing regulations for licensing of medical facilities and

for regular building inspections. Although NFPA standards are voluntary, their adoption by the regulatory

agencies of State and local governments have made

some of them mandatory.

National Committee on Clinical Laboratory Standards (NCCLS).—NCCLS is a private, nonprofit corporation devoted to upgrading health care by improving the quality of clinical laboratory methods and by

providing acceptable guidelines and standards for clinical laboratories. NCCLS was founded in 1968 by representatives of the clinical laboratory services professions, the Federal and State Government agencies with

responsibilities for public health, and diagnostic products companies that provide the reagents, instruments,

and systems used in clinical laboratory identification

and measurement. Its members work to produce voluntary consensus standards through numerous technical

committees.

NCCLS coordinates the process by which national

consensus on clinical laboratory standards is achieved,

and thus expedites the process by which NCCLS standards become adopted as national and international

standards. It works closely with its European counterpart, the European Committee on Clinical Laboratory

Standards, as well as with the International Organization of Legal Metrology, and ISO in developing and

harmonizing international standards.

Underwriters Laboratories, Inc. (UL)—UL is an independent not-for-profit corporation established in

1894 to help reduce or prevent bodily injury, loss of

life, and property damage. UL has developed standards and requirements covering medical and dental

equipment intended for professional use by personnel

m hospitals, nursing homes, medical care centers, medical and dental offices, and other health care facilities.

UL’s standards for safety are based on research and

cooperation by engineers, manufacturers, consumers,

and recognized specialists in many fields. Many UL

standards for safety are recognized as American National Standards by ANSI. UL is a member of ANSI

and assists in the review and development of American National Standards. Its staff members serve on

technical committees and subcommittees of various

domestic standards developing organizations such as

ASTM and NFPA, as well as international organizations such as IEC and ISO.

UL standards and requirements are the basis on

which UL’s registered certification mark may be affixed

to complying products by subscribers to UL’s services.

This system of marking is recognized by consumers,

regulatory authorities, and others who seek and rely

on third-party certification of products with respect

to safety. Federal, State, and municipal authorities, architects, building owners, and consumers may require

listing or classification by UL as a condition of their

acceptance of a device, system, or material having a

bearing upon risk of fire, shock, or other injury to persons or property. Although UL standards for safety

are voluntary, adoption by regulatory agencies has

made some of them mandatory (109).

International Organizations

International Organization for Standardization

(ISO).–ISO, formed in 1947, is an organization of national standards institutes involving over 84 countries.

Its objective is to promote development of worldwide

standards for the purpose of “facilitating international

exchange of goods and services and to develop mutual

cooperation in intellectual, scientific, technological,

and economic ability” (169).

ISO recognizes ANSI as the representative member

body for the United States. Other U.S. standards-
App. H—Consensus Standards Related to International Trade in Medical Devices • 207

setting organizations, including various Federal Government agencies and representatives of manufacturers, participate in many of ISO’s technical committees that are concerned with medical devices. These

groups together comprise the U.S. delegation to the

international organization. Members participate on

such technical committees as dentistry, implants for

surgery, mechanical contraceptives, prosthetics, and

transfusion equipment.

The development of international standards, of

which there are nearly 200 relating to medical devices,

is a slow, deliberative process. First, draft proposals

are submitted by interested national standards organizations or individuals to technical committees for

study. Most of the work of reviewing these proposals

is done through correspondence with its members. The

process of approving a standard may take as long as

6 or 7 years, but most proposed standards take about

3 years to gain approval as an International Standard.

Once a standard has become an International Standard, many national standards institutes and governments often seek to adopt it as their national standard as well. For example, ANSI, working through its

American Dental Association members, has adopted

the ISO standard for dental zinc silico-phosphate as

an ANSI standard (ANSI/ADA 21-1981). The reverse

case has also occurred, in which a specific national or

regional standard has become an International Standard. This situation is becoming more common as many

aggressive national and regional standards organizations attempt to have their own standards accepted internationally. For example, AAMI has introduced its

draft standard for implantable ventricular pacemakers

(AAMI 1P) to ISO, which in turn accepted it as a draft

International Standard (ISO 5841.1).

International Electrotechnical Commission (IEC).–

IEC was formed in 1906. In accordance with a formal

agreement between IEC and ISO, questions related to

international standardization in the electrical and electronic engineering fields are reserved to IEC and other

subject areas are the responsibility of ISO. If ISO

undertakes an international standardization matter

unrelated to a particular technology, it consults IEC

to safeguard any electrotechnical interests that maybe

involved.

The structure and process of standards development

by IEC is similar to the methods employed by ISO.

The recognized national standards institutes with

responsibility for development of standards for electrical products are IEC members. ANSI’s U.S. National

Committee is the U.S. member of IEC, and other U.S.

voluntary consensus organizations may participate in

IEC’s standards development process through its technical committees (169).

Other International Standards-Setting Organizations.—The organizations with specific areas of interest contribute their expertise to the development of

those standards. Many of these international voluntary organizations maintain close liaison with their national counterparts in the United States. The governmental role in these associations is limited to the extent

that an individual member of a national professional

society may also be a government employee and

as such have contact with her or his international

counterparts in the exchange of information.

The International Committee for Standardization in

Hematology develops reference materials and recommends standardized techniques in diagnostic hematology, blood transfusion practices, and related activities.

The International Union of Immunological Societies

and the International Federation of Clinical Chemists

develop specifications for methods of testing and

materials and also receive and organize international

tests to submit to the World Health Organization

(WHO) for acceptance as recommended procedures.

WHO also develops and promotes standards in medical devices. Expert panels and committees of WHO

have worked on such topics as standardization of diagnostic equipment and quality control in health laboratories.

The International Organization for Legal Metrology

(OIML) is a treaty body established in the early 1950s.

It is comprised of 48 countries, including the United

States, which joined in 1972. OIML works to harmonize international standards for legal measuring

devices, such as gasoline pumps and weight scales,

and, in the medical field, such devices as blood pressure gauges and electrocardiographs. The National Bureau of Standards represents the United States in

OIML. A U.S. advisory committee for legal metrology—consisting of representatives of Government

agencies concerned with legal measurements, manufacturers of measuring devices, and major standards

organizations such as ASTM and ANSI—provides

guidance to the National Bureau of Standards when

it represents U.S. interests in OIML.

Many international and regional trade associations

participate in developing their own standards, and

contribute to organizations such as ISO and IEC. Some

of these associations represent manufacturers of radiation equipment, surgical instruments, and clinical laboratory materials.

European Standards-Setting Organizations

Because of the large number of countries in Europe,

with their varied political, social, and economic systems, the environment is a “complex scenario against
208 ● Federal Policies and the Medical Devices Industry

which to review standards and regulations applying

to health care” (73). In addition to the governmentaffiliated and independent standards institutes within

the various countries, there are also regional standardsrelated organizations.

The membership of the European Committee for

Clinical Laboratory Standards represents health agencies, professional societies, and industry. Its objective

is to improve clinical laboratory practices through a

voluntary consensus mechanism (386).

The European Committee for Standardization (CEN)

is composed of the national standards organizations

of countries in the European Common Market, plus

Austria, Finland, Norway, Portugal, Spain, Sweden,

and Switzerland. Its major objective is to harmonize

Western European implementation of ISO and IEC

standards. In addition, it has developed approximately

60 “European Standards” in nonelectrotechnical fields.

CEN operates certification systems, usually with respect to European Standards, and systems for recognition for test results for national certification programs

where no European Standards exist (9).

The European Committee for Electrotechnical Standardization (CENELEC) is comprised of the national

electrotechnical committees of its member countries.

CENELEC seeks to harmonize the national electrotechnical standards of its member countries and uses

IEC publications as a basis for its activities. Its major

objective is to eliminate, through mutual agreement,

any technical differences between the national standards and certification programs of its members that

would result in trade barriers. In addition to its harmonization activities, CENELEC also develops European Standards in the electrotechnical field (9).

In general, each country has a national standards

institute that produces or sanctions standards, much

as does ANSI. These institutes also have technical committees comprised of government officials, manufacturers, and end-product users. For the most part,

standards established by these institutes are voluntary;

however, since each country has its own method of

administering and monitoring compliance with these

standards, the line between voluntary standards and

mandatory regulations is often blurred (73). Therefore,

it is useful to describe briefly key aspects of the standards setting and administering processes for several

major European nations, namely the Federal Republic

of Germany, the United Kingdom, and France.

In 1981, a group of international medical device

manufacturers formed the European Regulatory2Becton-Dickinson-France, S. A.; Beiersdorf A. G.; Cordis Dow, B. V.;

Johnson & Johnson, Ltd.; Medtronic France, S. A.; Miles Laboratories, Ltd.;

3M Europe, S. A.; Travenol International Services, Inc.; and Welcome

Reagents, Ltd.

Technical Affairs Study Committee, and conducted a

study in the major nations of Europe on the state of

regulatory affairs in the field of medical devices, including the diagnostic field. The resulting six-volume

report contains a listing of government regulatory

agencies, as well as information on certifying and

testing organizations and on national standards-setting. This report indicates that there is an increasing

trend for development of standards in Europe (102).

Federal Republic of Germany .—Two national laws

govern most of the Federal Republic of Germany’s governmental involvement in standards-related activity:

the Drug Law of August 24, 1976; and the Law on

Technical Equipment and Devices of June 24, 1968,

as amended August 13, 1979 (163). Although the Drug

Law is directed primarily to the pharmaceutical industry, it defines “drugs” to include certain surgical dressings, surgical sutures, and diagnostic products within

the term “fictitious drugs” (164,174). In addition, implantables are brought within the scope of the legislation once they are actually implanted (163).

The Drug Law is comprehensive and contains sections on manufacture, licensing and registration, clinical trials, recording of adverse effects, inspections,

labeling, and advertising (174). The Ministry of Health

has statutory responsibility when problems with regulated products are reported and corrective action is

necessary (163).

The Technical Equipment and Devices Law, administered by the Ministry for Labor and Social Affairs, sets forth standards for equipment safety. Special

provisions require that a manufacturer certify that

technical medical equipment is in proper condition and

that either the manufacturer or an officially designated

expert has subjected the equipment to final inspection.

Equipment controls and operating instructions must

incorporate use of the German language or utilize

standard symbols (164).

There are two principal standards-setting organizations in West Germany. The Verband Deutscher

Elektrotechniker (VDE) develops standards and provides certification testing and listing services for electrical components and systems. The other, the Deutsches

Institut für Normung (DIN), is a voluntary consensus standards organization that has developed standards in a number of areas. Standards involving electrical aspects are often published jointly by DIN and

VDE. In addition, there is a major testing-certification

organization called the Technischer Uberwachungs

Verein (TÜV) which deals primarily with complete

products, rather than their component parts. TUV

issues a “GS” (Geprüfte Sicherheit) mark that, although not mandatory, carries with it the same sort

of prestige as the UL mark in the United States (293,

135).
App. H—Consensus Standards Related to International Trade in Medical Devices • 209

United Kingdom.—In the United Kingdom, with its

national health system, the Government is the primary

user of medical devices. The Medicines Act of 1968

requires full premarket evaluation for drugs and medicines and sets forth requirements for licensing, manufacturing, inspecting, testing, and labeling. Certain

medical devices, such as surgical sutures, dental filling substances, contact lenses, intrauterine contraceptive devices, and certain radioactive medicinal products, have been brought within the regulatory framework

of the Medicines Act (174).

The British Standards Institution (BSI) is a voluntary standards-setting organization that was formed

in 1901. In addition to its standards-developing activities, BSI also provides testing and certification services. Although the standards developed by BSI are

voluntary, the Department of Health and Social Security (DHSS) has issued a recommendation that governmental purchases of medical devices comply with

existing BSI standards (149). Therefore, medical devices manufacturers regard BSI standards as mandatory in practice, as they must be met in order to market devices effectively in the United Kingdom.

As BSI standards cover only a relatively small number of medical devices, DHSS general specifications,

technical requirements, and voluntary “good manufacturing practices” have been developed to fill this

void. Through its Scientific and Technical Services

Branch, DHSS has also established a registration scheme

for manufacturers. The role of that branch is to develop, in conjunction with various trade associations,

suitable standards for quality assurance or good manufacturing practices, to assess the manufacturers’ compliance with those general standards, and to publish

a register of manufacturers complying with the good

manufacturing practices (149). In the event that this

voluntary scheme proves ineffective, the Medicines

Act provides for residual authority to extend its scope

to cover all medical devices (163).

France.—In France, the authority to control medical devices is derived from the Ministry of Health and

Family and the Ministry of Industry. The two major

mechanisms for control are the French Pharmacopoeia

and a “homologation” system (a system of official approval) (174).

The Ministry of Health and Family publishes Pharmacopoeia monographs that contain specifications and

descriptions for many sterile products, a variety of

plastic products, surgical dressings, sutures, various

tubing, and absorbent cotton. Requirements dictated

by the Pharmacopoeia are technically applicable only

to products sold to public institutions (which account

for over 90 percent of all medical facilities in France)

or to products that claim to conform to the Pharmacopoeia (164,293).

The homologation system is a process of obtaining

official government approval applicable to a listing of

devices that is periodically reviewed and updated. Although approval is mandatory only for products purchased by public institutions, the homologation system is linked to reimbursement procedures under the

French social security system. Therefore, approval is

necessary whenever a purchaser wishes to apply for

reimbursement (164). Until recently, approval had

been granted by an interdepartmental commission, and

product-specific requirements, specifications, and procedures for testing were stipulated by decree.

In January 1983, France introduced an entirely new

scheme of approval. Although it is unclear how the

new scheme will operate in practice, the interdepartmental commission has been abolished, and a National

Committee of Homologation, which has full responsibility for the approval process, has been created

within the Ministry of Health and Family. The National Committee has five subcommittees, composed

of experts drawn from the ministries, hospitals, and

universities, and charged with defining the homologation procedures. The subcommittees operate in the

areas of: imaging, operating theaters, artificial organs

and prostheses, anesthesia and reanimation, and diagnostic equipment and monitoring (163).

In general, approval requests must be presented to

the Ministry of Health and Family by an authorized

agent established in France, and a testing laboratory

will then be assigned. In practice, only laboratories

within the Groupment des Laboratoires des Materiels

de Technique Medicale are adequately equipped and

staffed to do the work. For an electrically powered

product, the French Electrical Code is applied as the

minimum standard. If a particular product standard

exists, it is also applied. Clinical testing may be required by physicians assigned by the ministry (293).

The Association Francaise de Normalisation (AFNOR)

is France’s primary standards organization. AFNOR

is a private, public service association that centralizes

and coordinates all work and studies concerning standardization, much as does ANSI. Formed in 1926,

AFNOR is a voluntary organization of manufacturers,

consumers, professional associations, and government

representatives. Standards developed by AFNOR are

voluntary; however, they may become mandatory if

adopted for use within the homologation system. In

1943, AFNOR was given governmental authority to

develop public standards and to administer the mark

“NF” as indicating conformity with a standard.

Other Foreign Organizations

Japan.—The Ministry of Health and Welfare regulates the importation and sale of medical devices pur-
210 . Federal Policies and the Medical Devices Industry

suant to the Pharmaceutical Affairs Law. In July 1983,

an omnibus bill was passed making extensive changes

in Japan’s standards and certification system. The omnibus bill is the culmination of over 4 years of bilateral

discussions between the United States and Japan (121).

Standards in Japan are normally developed through

advisory committees to Japanese Government ministries (359). The Japanese Industrial Standards Committee (JIS) within the Ministry of International Trade

and Industry is of particular importance to the medical devices industry. Products conforming to JIS standards and testing requirements are entitled to bear the

“JIS” mark, which is the most prominent and widely

used certification mark in Japan.

Prior to passage of the recent amendments, only JIS

standardized medical devices were exempt from the approval process. The new legislation permits certain

non-JIS standardized devices to bypass the approval

process. The devices exempted are those for which the

utility, efficiency, and safety is generally acknowledged, including such items as surgical knives, tweezers,

medical scissors, sterilizers, operating tables, and

stethoscopes (121).

Canada.—In Canada, the Department of National

Health and Welfare’s Bureau of Medical Devices (BMD)

is the central point for mandatory standards. Under

the Food and Drug Act of 1953, the department was

granted authority to adopt standards and create regulations for medical devices. To date, BMD, which

was created in 1975, has developed seven medical device regulations: 1) contraceptives, 2) cardiovascular

pacemakers, 3) hearing aids (revoked in 1979, but the

bureau is working to have them reestablished), 4)

mobile oxygen inhalators, 5) blood collection tubes,

6) disposable insulin syringes, and 7) electromedical

devices. In developing these standards, BMD examined existing national voluntary standards and other

international and foreign standards which could be

adopted or modified, and then based its standards

upon a synthesis of them.

The Canadian Standards Association (CSA) is a

voluntary, nonprofit, autonomous organization that

provides standards-writing and certification services.

Its members are drawn from the industrial, governmental, private, and educational sectors. In the mid1970s, CSA initiated a Health Care Technology Program, whose goal is to develop consensus standards

in the medical engineering field and to implement those

standards throughout Canada through education, professional societies, and provincial or federal legislation

(90). CSA is also a testing house for certification of

medical devices. Manufacturers can pay to have their

products certified as complying with CSA standards

and certain other relevant standards.

The majority of Canadian medical device standards

are not mandatory. However, since almost all of Canada’s hospitals are public, various provincial governments require that certain medical devices meet CSA’s

standards or some other national, international, or

foreign standard, such as those of AAMI or ISO.

This requirement has the effect of making many

voluntary standards mandatory in operation. For example, all electromedical equipment sold or used in

any Canadian province must be “approved,” which

in effect means that the product must be shown to conform to CSA standard C.22.2 No. 125 (90). Although

certain CSA standards are substantially similar to UL

standards in the United States, CSA does not automatically certify products certified by UL, but conducts

its own testing (463).

Like ANSI (the American National Standards Institute), the Standards Council of Canada, a nonprofit

organization, coordinates other standards-setting organizations and sanctions the standards developed by

these bodies.

Mexico.—The Mexican Government has no uniform

system of standards development that affects medical

devices (301). The importation of medical products is

governed only by the customs law and not by medical device or pharmaceutical legislation as in other developed countries. Entry requires a certificate of origin

and description of the product. If a product bears a

certification of compliance with the standards of the

producing country, such as a UL mark, this certification is generally accepted by customs officials.

Change in the enforcement of customs laws in Mexico can generally be traced to national and international economic policy issues, such as the effect of imports on Mexican employment and other such economic

concerns. These reasons usually are not directed at

control of the quality, safety, or effectiveness of the

products (301).

U.S. Government Agencies Involved

in Standards-Setting Related to

International Trade

The GATT Standards Code establishes new international ground rules in the area of technical (nontariff) barriers to trade. It sets forth international rules

among governments for regulating the procedures by

which standards and certification systems are prepared, adopted, and applied and by which products

are tested for conformity with standards (359,380).

The basic premise of the code is that standards-related

activities should not be used as mechanisms to restrict

unnecessarily international trade (46).
App. H—Consensus Standards Related to International Trade in Medical Devices . 211

Although the code is directly binding only on the

central governments of its signatories, these governments are obliged to take reasonable measures to ensure that regional, State, local, and private organizations also comply with the code’s provisions (359).

Therefore, the code provisions affect governmental

and nongovernmental standards, whether voluntary

or mandatory, and whether developed by central, regional, State, or local governments or private sector

standards organizations.

Three U.S. Government agencies play a significant

role in the implementation of the Standards Code in

the United States: the Office of the U.S. Trade Representative, the Department of Commerce, and the Department of Agriculture (380). The Department of

Agriculture’s role, while important with respect to

overall implementation of the code, is beyond the

scope of this paper. Activities within the Department

of Health and Human Services are outlined below.

U.S. Department of Health and Human Services

The National Center for Devices and Radiological

Health in the Food and Drug Administration (FDA)

frequently interacts with domestic and international

voluntary standards-setting organizations. Domestically, the national center contributes to the review

and development of standards by organizations such

as ANSI, AAMI and ASTM.3 FDA also participates

in development of international standards through its

work on the technical committees of both ISO and

IEC. However, U.S. Government agencies have neither control over nor any official leadership role in the

domestic or international private voluntary standardssetting process.

Recently, U.S. Government agencies—specifically

FDA—have increased their participation in voluntary

standards-setting activities because of two Federal policy initiatives: the GATT Standards Code, as implemented in the Trade Agreements Act of 1979 (19

U.S.C. § 2531-2573) and Office of Management and

Budget (OMB) Circular A-119, Both of these policy

initiatives establish guidelines for and encourage Federal Government agency participation in domestic and

international voluntary standards-setting activities.

The Trade Agreements Act recommends the use,

where appropriate, of international standards as the

basis for developing domestic standards. FDA’s work

with voluntary organizations is important, therefore,

to ensure that the U.S. view is expressed and that internationally developed standards are consistent with

3FDA’s activities regarding mandatory performance standards are discussed

in ch. S.

U.S. national standards in terms of product safety and

effectiveness.

OMB Circular A-119 sets forth as Federal policy that

the U.S. Government will rely on voluntary standards,

both domestic and international, where appropriate,

in lieu of governmentally developed standards. Circular A-119 also specifies that Federal employee participation should not in any way attempt to dominate

the voluntary process (21).

The Centers for Disease Control (CDC) has also

been active in voluntary standards-setting activities in

the medical devices field. CDC provides technical

assistance to organizations such as the National Committee on Clinical Laboratory Studies through CDC’s

work with various professional societies and through

information received from State health departments

and other public and private medical laboratories.

Office of the U.S. Trade Representative

In connection with its responsibility for setting and

administering overall trade policy, the U.S. Trade Representative (USTR) coordinates the development and

execution of the U.S. standards-related trade policy

(419). USTR is responsible for resolving standardsrelated trade disputes between the U.S. and foreign

governments, overseeing the general implementation

of the Standards Code in the United States and coordinating the international trade activities of other U.S.

Government agencies that engage in standards-related

activities that may significantly affect trade, and negotiating bilateral standards arrangements (380).

Under the Standards Code, any signatory may question another signatory’s compliance with code provisions. Bilateral or multilateral consultations are encouraged to resolve disputes. In the United States, a

private party may informally raise with USTR a foreign practice that appears to be inconsistent with the

code or otherwise denies benefits to the United States

under the code (380). USTR will then pursue the

resolution of problems, keeping the complainant apprised of its activities. Problems arising under the code

usually involve: failure by signatories to provide adequate information on their standards-setting activities,

failure by importing governments to adopt standards

set by international organizations, nonacceptance by

importing countries of test data generated in the United

States, and denial of access to certification systems

(359).

U.S. Department of Commerce

National Bureau of Standards (NBS) .—NBS has

been delegated the responsibility for establishing and
212 ● Federal Policies and the Medical Devices Industry

maintaining the U.S. inquiry point for Standards Code

matters, the central repository for standards and certification information, and a technical office for nonagricultural products. The responsibilities delegated to

NBS are carried out through the Office of Product

Standards Policy’s Standards Code and Information

program.

As the U.S. inquiry point mandated by the Standards Code, staff of the Standards Code and Information program notify the GATT Secretariat of proposed

U.S. regulations potentially having an effect on trade.

They receive notices and information on proposed

foreign regulations and disseminate the information

through several media and directly to interested U.S.

parties. A primary objective of the notification program is to encourage review and comment on proposed foreign regulations. Foreign notifications are

routed through various Government agencies, such as

the Bureau of Industrial Economics in the Department

of Commerce (DOC); agency members of the Interagency Committee on Standards Policy; private standards organizations; and industry groups.

This program also operates the National Center for

Standards and Certification Information, which is the

national repository for standards documents. The center responds to general inquiries about the existence

of specific standards and regulations and maintains a

reference collection of voluntary and mandatory U.S.

standards, as well as major foreign and international

ones. The technical office within the program provides

assistance in the areas of exchange of information and

dispute settlement.

To market products in foreign countries, U.S. exporters must be informed of the testing procedures,

approval programs, and certification rules in effect in

those countries. To date, there are no centralized or

accessible reference collections that can provide exporters with this essential information (359). Current

funding and staff resources within the Standards Code

and Information program are insufficient to allow it

to expand effectively into this area (1,91). However,

the center has begun to collect certification information on an informal basis through its collection of

materials on foreign and international standards activities and through information provided by U.S. trade

and professional organizations.

International Trade Administration (ITA).—The

Trade Agreements Act directs the USTR and the Secretaries of Commerce and Agriculture to consult with

the private sector for technical and policy advice on

the implementation of the Trade Agreements Act and

the Standards Code (46,359). In order to meet its

responsibilities, DOC has established an Industry

Functional Advisory Committee (IFAC) on Standards

for Trade and Policy Matters. IFAC, administered by

ITA in DOC, is composed of approximately 20 members drawn from Industry Sector Advisory Committees within DOC and an approximately equal number drawn from private sector groups involved in

standards-related activities (359).

IFAC is responsible for advising USTR on matters

concerning trade, the operation of existing trade agreements, and other matters connected with U.S. trade

policy. IFAC provides detailed policy and technical advice, information, and recommendations concerning

standards and their effect on trade and the implementation of the Standards Code (359).

Although the mandates of the Standards Code are

technically applicable only to the Federal Government,

the Trade Agreements Act legislation calls on the President to promote adherence to the code principles by

State and private sector bodies (19 U.S.C. § 2533). To

this end, ITA has issued voluntary procedural guidelines for State and local governments and private sector organizations engaged in standards development,

product testing, and certification systems (314).

Representation of U.S. Interests in International

Standards Organizations.—The Trade Agreements

Act directs the U.S. Secretaries of Commerce and Agriculture to keep adequately informed of international

standards-related activities, to identify those activities

that may have a substantial effect on U.S. commerce,

and to coordinate those efforts with USTR. Although

the act does not designate any specific private organization as the “official” representative of U.S. interests, it confirms the role of U.S. member bodies in private international standards organizations, such as the

ANSI/ISO relationship.

The Secretary of Commerce has authority to determine that a member body is not adequately representing U.S. interests and to make arrangements for adequate representation (380). For any governmental

international standards organizations in which U.S.

interests are represented by one or more Federal agencies, the Secretary is directed to encourage cooperation among the agencies to seek a uniform position.

In addition, the Secretary is directed to encourage such

Federal agencies to seek information from and cooperate with any affected domestic industries (380).

The Standards Code and Information program fulfills

DOC’s obligations with respect to ensuring adequate

representation of U.S. interests in international standards-setting through two major activities. First, the

program’s technical office responds to any information, complaints, or criticisms concerning participation in international standardization activities. Second,

the program maintains statistics and information on

U.S. participants in international standards-related

activities (359).
App. H—Consensus Standards Related to International Trade in Medical Devices ● 213

Problem Areas for Medical Devices

Standards in International Trade

At an OTA workshop in August 1983, representatives of selected members of the Health Industry Manufacturers’ Association (HIMA) identified certain problems related to standards and international trade. All

the participants came from large companies that engage

in foreign trade. Although their views may not be

generalizable to the medical devices industry as a

whole, they do indicate the experiences and perspectives of companies from several areas of medical devices (see app. B for a list of workshop participants).

It should also be borne in mind that a complete examination of standards-setting would require consideration of the benefits to purchasers and users of devices.

This section discusses issues raised at the workshop

as well as information from Government agencies and

other industry representatives.

Development of Standards

Rationale or Need for Standards.—Workshop participants commented that insufficient attention is given

to the rationale for developing standards. Developing

medical device standards may proceed with little or

no demonstration of concerns related to clinical safety

and effectiveness (118). For safety standards that are

engineering- or technology-based, much time and effort may go into creating standards important from

an engineering point of view but of limited concern

from a medical point of view. One way to demonstrate

that a standard is reasonable is to include a rationale

that defines the standard’s purpose and limitations

(118).

A related comment was that many standards are developed without any attempt to examine costs and

benefits. Highly restrictive, costly, hardware-oriented

standards are produced where adequate nonhardware

alternatives (such as education, training, and preventive maintenance) for resolving the problem may exist. Publication of a rationale would facilitate public

review and comment and would permit more appropriate application of standards (89).

The workshop participants advocated greater clinical input into standards development. Recently, a

trend to involve medical professionals has been developing, particularly in the United States and in Canada, but many medical professionals appear reluctant

to take the time away from their practices (or other

responsibilities) or incur the expenses connected with

participation. Consequently, standards may contain

requirements that differ from those necessary to assure

the safety and effectiveness of medical devices (145).

There was speculation that some foreign countries

have reacted to the 1976 Medical Device Amendments

by promulgating their own standards, both voluntary

and mandatory. The question was raised of whether

or not standards are needed, considering that many

manufacturers produce devices to specific internal corporate standards based on current scientific and technical information, the marketability of the devices,

and protection of the company from personal injury

liability.

Access to Information. —When standards—domestic,

foreign, and international—are being developed, it is

often difficult for an individual or company to gain

timely access to information so that comments can be

submitted. A major objective of the Standards Code

is to make standards-setting and certification activities open to all interested parties, and code signatories

must follow certain procedures for new or amended

mandatory standards and certification system rules

(380). However, few foreign countries have detailed

specific requirements regarding public notice, and the

Standards Code requirements speak only in terms of

reasonableness. Although none of the code signatories

maintain notice procedures that actually violate the

code, U.S. manufacturers have encountered difficulties

in obtaining the timely, adequate information necessary for making meaningful comments (359).

FDA’s notices of proposed standards development

may not give enough information about the purpose

or rationale to determine the scope or need for comments (21 CFR pt. 866). At the local level, users of

standards, manufacturers, or consumers are not all

members of national organizations and do not all

subscribe to the publications (such as the Federal Register for domestic notices and the Commerce Business

Daily for foreign notices) in which notices are published. Consequently, they may not take part in the

comment process.

In January 1980, HIMA surveyed its membership

to obtain information regarding members’ international marketing activities, monitoring of regulations

and product standards, and participation in foreign industry organizations. According to the survey results,

manufacturers typically rely on foreign agents and

distributors for information on changes in foreign regulations and product standards, and many have designated a specific employee, stationed either in the

United States or abroad, to monitor standards-related

developments.

Whereas over 70 percent of the manufacturers responding to the survey relied on distributors, agents,

and employees as information sources, 35 percent of

the respondents obtained information directly from

U.S. Government sources and 21 percent obtained the
214 ● Federal Policies and the Medical Devices Industry

information directly from foreign governments or

foreign industry organizations (146).

Some European countries with only a few manufacturers in specialized fields such as medical devices have

developed standards swiftly. These standards are often

based on locally manufactured products and may, in

fact, serve to restrain import trade. The standardssetting government may justify its standards by asserting that they are based on international standards

“with qualifications, ” but the qualifications may be

substantial and belie the original standard. Because

these standards are often quickly enacted, U.S. standards organizations and interested manufacturers often

have difficulty submitting comments in a timely manner. Once these standards are finalized, U.S. manufacturers may have difficulty in having their products

conform to the foreign standards.

Suitable Representation.—The expense of analyzing drafts, preparing comments, and attending international meetings often makes it particularly difficult

for small companies to participate, since the cost of

participation is the burden of the individual committee members. In the private sector, it is usually the

manufacturer who pays the expenses of the employee

representative. The review and comment work of committees usually takes place over a period of months,

or years in some cases. As a result, the interests of

small manufacturers (and others unable to attend international meetings) in international standards-setting

are often not taken into account.

Although 98 percent of the manufacturers responding to the HIMA survey were involved in the export

or foreign manufacture of medical products, only 27

percent indicated membership in foreign industry organizations and only 25 percent reported active direct

involvement in international standards organizations.

The manufacturers that did participate in international

standards development reported employee participation in various technical committees of organizations

such as IEC, ISO, NCCLS, and OIML—as well as the

national standards organizations of Australia, France,

West Germany, and the United Kingdom (146).

Even with improved representation in international

standards setting, U.S. interests may be unable to influence decisionmaking at the international level. European countries involved in the regional standards

setting activities of organizations such as CEN and

CENELEC often vote as a bloc in ISO or IEC to establish European technology as the basis for international

standards (249).

Application of Standards

Cost of Conforming to Standards.—In the United

States, UL or NFPA standards are often specified in

public municipal codes, such as building and safety

codes, or in purchasing specifications. Products must

then bear a UL mark or other form of approval to be

used within those jurisdictions. A device may be

subject to design and performance standards as well

as installation and use standards. Each time a test is

conducted, additional costs are incurred. For example, some electrical devices require a UL mark as well

as conformity to NFPA fire and safety codes. In addition, a foreign government might require different or

additional tests and markings for the same product.

Although manufacturers consider some medical devices standards, such as those developed under the

1968 Radiation Control for Health and Safety Act, to

have significantly improved the safety and quality of

the products, they also maintain that the improvements have raised the cost of research, development,

and final products.

In foreign countries, the cost to a U.S. manufacturer

of complying with foreign standards that differ from

domestic standards must be built into the price of its

products. This can make U.S. products more expensive than local foreign ones, and thus less cost competitive. To minimize the costs of additional testing

or procedures related to meeting foreign and domestic standards, as well as for other reasons, U.S. manufacturers have set up overseas operations. Establishment of foreign manufacturing subsidiaries by U.S.

companies diminishes the balance-of-trade advantage

for the United States.

Interpretation and Reliability of Information.—The

existence of an international or foreign standard, and

knowledge of its existence by a U.S. manufacturer, has

only limited value. It is more important to the manufacturer to know how that standard will be interpreted

by local or national officials, or other certifying bodies

such as testing laboratories, government reimbursement agencies, or insurance providers.

In the Federal Republic of Germany, for example,

there are DIN standards for medical device components, but within the country the officials of the various states interpret these standards differently. Differing interpretations can result in costly delays in supplying

products or in cancellations of orders and contracts.

In Germany, U.S. importers also face problems relating to insurance coverage. For example, although

not legally required, a customer’s insurance carrier

asked the importer of an ultrasound imaging device

to certify that the product met radiofrequency interference standards (235). This action caused considerable expense to the manufacturer in legal fees and

delayed introduction of the product.

This situation occurs in other countries as well where

the ultimate legal responsibility for radiofrequency interference (or any other responsibility for equipment
App. H—Consensus Standards Related to International Trade in Medical Devices ● 215

safety or performance) rests with the user as opposed

to the manufacturer. In order to obtain insurance coverage in these situations, the user’s case is much stronger

if it can be shown that the product meets, or has been

certified to, the requirements of an applicable standard (293).

Most companies doing business internationally must

rely on their market researchers to identify standards

or other requirements that they must meet or on local

distribution agents for their knowledge of local administrative procedures. Obtaining information through

these sources is costly and time-consuming. It is all the

more difficult for those companies that cannot afford

researchers or local agents.

Once manufacturers have obtained information regarding foreign standards-related practices, they often

encounter difficulties in confirming the accuracy of

that information and determining its practical implications. A major difficulty in foreign standardization

activities is determining what is required versus what

is customary or desirable in certain markets. Manufacturers report that certain foreign standards requirements that appear to be mandatory may in practice be negotiable with the inspector.

For example, in the United Kingdom, one manufacturer succeeded in overcoming a seemingly mandatory

DHSS radiation protection standard for X-ray equipment that contained an unworkable limit on fluoroscopic exposure. Through negotiations with the inspector involved, the manufacturer was able to obtain

approval of its product (235).

Effect of Standards on Innovation.—The interpretation of standards by foreign governments and the

reliability y of information can be linked to the issue of

how standards keep pace with new technologies. Some

countries, such as Mexico, reportedly use out-of-date

standards and have rejected products not meeting these

standards. A recent example involved implantable

pacemakers (301.).

Although some standards have provisions for assessing new or improved products, others are written to

preclude newly developed or improved products, such

as the replacement of digital monitors for analog

equipment. If standards are not written to accommodate product changes, introduction of new technologies will be restricted by existing standards and will

serve as a barrier to trade.

The process of changing standards, especially international standards, is often as long and cumbersome

as the initial development process. New technological innovations in medical devices may thus be barred

from certain countries, either voluntarily or involuntarily, because the standards for the devices have not

evolved so quickly as the products themselves.
Appendix 1. —Governmental Regulation of

International Trade in Medical Devices:

United States, Canada, Japan, United Kingdom,

France, Federal Republic of Germany, and Mexico1

United States

Regulation of Imports

Two types of government regulations affect the ability of foreign medical devices to compete in the U.S.

market. The principal focus of this appendix is the first

type—those regulations that directly impose requirements on foreign manufacturers and importers, or on

the imported device itself. The second type of regulation indirectly influences the actual sales of imported

medical devices by affecting their competitiveness with

devices manufactured in the United States.

The regulations of the Food and Drug Administration (FDA) are designed to ensure that only safe, effective, and truthfully labeled medical devices are sold

in the United States. In theory, this means that foreign

manufacturers and imported devices must meet the

same criteria as U.S. firms and domestically manufactured devices. In practice, however, because of budgetary constraints, foreign manufacturers of medical

devices are treated somewhat differently, since they

are not inspected so regularly as domestic manufacturers, and, unlike their domestic counterparts, they

receive advance notice of an upcoming inspection.

The Customs Service, which is supposed to ensure

that medical device importers comply with the general rules applicable to all imported products, in 1979

delegated certain of its general responsibilities to FDA

(304).

Requirements of the Food and Drug Administration.—FDA regulations impose a number of requirements that must be fulfilled before a device can even

be considered for import approval, and these requirements are the same as those imposed on domestic manufacturers (see ch. S). Registration of a foreign manufacturer of medical devices is voluntary, but FDA tries

to encourage such establishments to register. Registration is mandatory for the importer (initial distributor)

of a foreign medical device (21 CFR 807.20, 1982).

Unless the importer is registered, FDA will not allow

the import to be released for sale in the United States.

A foreign manufacturer or distributor must also

supply FDA with a

IExcerpted from a paper

Hays & Handler (181).

216

list of every device that it exports

prepared for OTA by Kaye, Scholer, Fierman,

to the United States (21 CFR 807.40, 1982) or authorize an exclusive distributor to file the medical device

listing on its behalf. Failure to list a device will result

in its exclusion from the United States.

Foreign manufacturers, unlike domestic producers,

usually have at least 30 days notice prior to an FDA

inspection. Because of the expense and logistics involved, foreign inspections by FDA are infrequent.

Furthermore, it is likely that they will become even

more infrequent in the future because of recent reductions in FDA travel funds.

The third set of FDA preimportation requirements

involves premarket notification and approval. The

scope of these requirements varies based on the nature

and history of the product. If a product was being imported into the United States prior to the Medical Device Amendments of 1976, it may continue to be imported without notification. But if a device was not

being imported prior to 1976, the manufacturer or importer is required to submit a premarket notification

to FDA. If FDA finds that a product is substantially

equivalent to a preamendments device, importation

and marketing will be permitted. If a device is not

substantially equivalent to a preamendments device,

it may be subject to the further requirement of premarket approval (see ch. S)

. In that case, neither importation nor marketing of the device is permitted until

approval is received from FDA.

The fourth form of preimportation requirement

relates to manufacturing. Both foreign and domestic

manufacturing establishments are subject to inspections to ensure compliance with good manufacturing

practices, although the right of such inspection may

be limited by foreign governments or the foreign firm

involved. If a satisfactory arrangement for an inspection cannot be made, FDA has the authority to exclude

the product since it would be unable to determine

whether the device met the good manufacturing practices requirements of the Federal Food, Drug, and

Cosmetic Act. (FDA has encountered few, if any,

problems in inspected medical devices firms in the

countries included in this appendix (204). )

Pursuant to a 1979 delegation of some of the Customs Service’s authority, FDA monitors compliance

with customs regulations, collects samples, issues

notices of sampling, and issues notices of refusal of

admission at certain ports (384). Figure I-1 outlines the

steps involved in clearing customs.
App. I—Governmental Regulation of International Trade in Medical Devices ● 217

.———.— -.. -— ——. - — — ...— ——.——. .———.—— —

Figure 1-l.— FDA Import Procedures for Foreign Medical Devices

i

25-406 0 - 84 - 15
218 . Federal Policies and the Medical Devices Industry

There is no evidence to suggest that FDA regulations

were adopted for the purpose of erecting barriers to

international trade in medical devices, or that they are

administered with such an intent. As a practical matter, however, certain regulations do have a different

impact on importers than on domestic manufacturers.

For example, domestic producers may have an advantage with respect to participation in the notice and

comment process and informal negotiations leading to

the development of regulations. Not all regulations,

however, operate to the advantage of domestic producers. For instance, due to logistical concerns, inspections under the good manufacturing practices regulations are more frequent, and undoubtedly more

burdensome, for domestic producers than for foreign

manufacturers.

FDA has a variety of administrative sanctions equally applicable to domestic and foreign manufacturers

that can be used to prevent the marketing of adulterated or misbranded medical devices. There are, however, important practical distinctions between FDA’s

authority over domestic medical devices and imported

devices. In domestic commerce, FDA has only formal

statutory authority to bring enforcement actions such

as seizures with respect to devices when those devices

are actually misbranded or adulterated. FDA’s discretion is therefore limited by the requirement that it be

able to prove that a device is in fact adulterated or

misbranded. FDA’s enforcement authority over imported devices is broader; it has the authority to act

when an imported device appears to be misbranded

or adulterated (21 U.S. C. 381(a), 1976; (294)). The

“appears” standard significantly modifies the usual

burden of proof and offers more discretion to FDA to

detain or otherwise halt potentially defective or hazardous medical devices before they are distributed to

consumers in the United States. On the basis of this

authority, FDA actively monitors imports to prevent

the introduction of offending devices.

On the other hand, it must be noted that FDA has

a variety of informal administrative remedies, such as

regulatory letters or recalls, which it employs where

it does not wish to institute a formal enforcement action. Some of these actions may be more difficult to

apply to foreign manufacturers than to domestic manufacturers.

Customs Service Regulations.—The result of the

delegation of customs’ authority to FDA is that the

only customs Service regulations applicable to medical devices are those generally applicable to all imported products. These regulations fall into three categories: those pertaining to “entry” of goods into the

United States, those pertaining to the assessment of

duties on imported products, and those which pertain

to the physical appearance of imported goods.

This classification system may change in the near

future. The U.S. International Trade Commission

recently prepared a study in anticipation of the conversion of the U.S. tariff classification into an internationally agreed-upon, harmonized system of tariff

classification. If adopted, the system will result in a

more uniform classification of medical devices between

different countries, and thus make the gathering of statistical data easier, but it will have little economic effect on imports into the United States.

Tariffs applicable to medical devices are now generally in the range of 5 to 10 percent, which is comparable to the rates applied by other countries to the

imports manufactured in the United States.

The third set of regulations administered by the Customs Service relate to the physical appearance of, and

markings on, devices. Although these requirements

must be met by importers, they have no significant

impact on the pattern of trade in medical devices.

U.S. Trade Laws.—In addition to being subject to

FDA and Customs Service regulations, imports of

medical devices are subject to regulation under the general U.S. trade laws. These laws, which are briefly described below, can be used to impose additional duties,

quotas, or other restrictions on the importation of

medical devices that might cause injury to the domestic medical devices industry. There are two basic categories of such trade laws: those that impose restrictions when imports that are traded “unfairly” injure

the domestic industry, and those that permit restrictions on imports where there is injury to the domestic

industry, without regard to “unfairness. ”

The unfair trade laws have not often been invoked

in the medical device area. Nor has any part of the

medical device industry yet attempted to bring a countervailing duty or antidumping case against imported

medical devices.

Two actions have been brought against importers

of medical devices on the grounds of unfair trade practices. In June 1982, the U.S. International Trade Commission instituted an investigation involving certain

computed tomography (CT) scanner and gamma camera medical diagnostic imaging apparatus. The investigation involved allegations that equipment imported

from Israel violated a patent granted to a U.S. company (312). In March 1983, the commission made a

preliminary determination that there was no violation

and the case was terminated. In September 1983, the

commission initiated a second investigation involving

cardiac pacemakers and components (322). This complaint was also based on alleged patent infringement

and is currently pending before the commission.
App. I—Governmental Regulation of International Trade in Medical Devices . 219

Regulation of Exports

In the United States, the export of medical devices

is not regulated to anywhere near the same degree as

imports. To the extent that export regulations do exist, they are administered principally by two agencies,

FDA and the Office of Export Administration (OEA)

in the U.S. Department of Commerce.

FDA Export Regulations.—For export purposes,

medical devices can be divided into three categories.

The first category of devices is by far the largest; any

medical device that can be marketed legally in the

United States can be exported legally from the United

States without prior approval by FDA.

The second category of devices are those that cannot be marketed in the United States, but that can be

exported without FDA approval if the product (sec.

801 (d)(l) of the Federal Food, Drug, and Cosmetic

Act):

● meets the specifications of a foreign purchaser,

• does not conflict with the laws of the country of

the foreign purchaser,

. is labeled for export, and

. is not sold or offered for sale in domestic commerce.

Prior FDA approval is not required for exports under

section 801(d)(l), but FDA may at any time require

an exporter to show that the exports that it is making

under this section comply with the section’s four requirements.

The third category of medical devices, those exported under section 801(d)(2) of the act, includes certain types of adulterated or misbranded devices that

may be exported only with specific FDA approval and

not under the less strict standards of section 801(d)(l).

The third category specifically includes products that

violate performance standards; that are subject to but

have not received premarket approval; that are subject to limited investigational use, or that are banned

in the United States. As a practical matter, most devices requiring FDA approval for export are those that

require but have not yet received premarket approval

or that are subject to limitations as investigational

devices.

To obtain FDA approval for export of a medical device in the third category, an exporter must submit to

FDA an “Export Request. ” This request must contain

a description of the device and its status under U.S.

law, and a letter of acceptance from the government

of the importing state. This letter of acceptance must

state:

• that the device is not in conflict with the laws of

the importing state,

● that the foreign government has full knowledge

of the status of the device in the United States, and

● that the import is permitted (along with any restrictions that might be imposed).

On the basis of this information, FDA will approve

the exportation of the device if it would not be contrary to public health and welfare.

The FDA approval process for exports under section

801(d)(2) raises two problems for U.S. exporters. The

first arises from the need to obtain explicit authorization from the foreign government for the importation

of a device and is also faced by exporters under section 801(d)(l). Since many countries have no laws

governing the approval of medical devices, it is difficult for these countries to inform FDA that a device

is approved for import. In such cases, FDA will accept a statement from a foreign government that it has

no laws prohibiting the importation of a particular

medical device. This procedure may only partially

alleviate the difficulty because in many of these countries no one is authorized by law to make even such

a limited statement to FDA. The second problem is

the vagueness of the “public health and welfare” standard used in section 801(d). Neither the Medical Device Amendments of 1976 nor the legislative history

indicate whose health and safety is to be protected by

FDA.

In practice, FDA’s reliance on the standard is minimal; the decision to allow an export is usually made

simply on the basis of whether the foreign government

approves the importation of the device. From October

1, 1981 through September 30, 1982, FDA issued 260

letters approving export of medical devices under section 801(d). In the same period, eight requests were

not approved. From October 1, 1982 through March

31, 1983, 116 approvals for export were given, five

devices were not approved, and one previous approval

was rescinded.

Department of Commerce Export Controls.—Medical devices, along with all other U.S. exports, are

subject to the export controls in the Export Administration Act of 1979. That act authorizes the President

to impose controls on exports for reasons of national

security, foreign policy, and short supply.2 The principal authority to administer these controls has been

given to the Commerce Department’s OEA; other

agencies including the Departments of State, Defense,

Energy, and Treasury have an advisory role in OEA

licensing decisions.

‘The Export Administration Act originally expired on Sept. 30, 1983. The

controls under the act were at first extended on a temporary basis by the

President pursuant to the authority of the International Economic Emergency

Powers Act. Congress later passed a bill extending the act until the end of

February 1984. Congress is considering reauthorization with a variety of

amendments, but it is not possible to predict what new provisions will be

included.
220 ● Federal Policies and the Medical Devices Industry

All exports from the United States must be authorized by either a general or a validated export license.

A general license is an authorization to export granted

by regulation rather than by specific application. General licenses can be used to export any good to any

destination, as long as neither the good nor the destination is controlled. Validated licenses are required

whenever the export of a specific commodity is controlled to a specific destination.

Determination of whether a particular commodity

requires a general or validated export license is made

with reference to the Export Administration Regulations and the Commodity Control List.

Medical devices fall into several product classifications of the Commodity Control List, depending on

the nature of the product and its technological sophistication. For example, most medical, surgical, and dental supplies are classifiable within the miscellaneous

product group item 6999 G, “other commodities not

elsewhere specified, ” which can be exported under general license except to Cuba, Kampuchea, North Korea, and Vietnam. Most X-ray equipment is classified

in the Electronic and Precision Instruments Product

Group in item 1533A, which requires a validated license to any destination other than Canada.

In most cases, the requirements applicable to medical devices are less than clear because the Government’s interests in restricting exports are based not on

their status as medical devices but on the fact that they

include some form of technology that the United States

wishes to control, such as computer or laser technology. An example can be seen in item 1522A, “lasers

and laser systems including equipment containing

them,” for which a validated license is required for all

destinations except Canada. Although most medical

laser systems would appear to be covered by this classification, the explanation of this item in the Commodity Control List provides no further specific guidance. Treatment of medical equipment incorporating

semiconductor or computer technology can be even

more complicated and can depend on the speed of the

computer, its capacity, the capability of the computer,

and the materials from which the semiconductor is

made. Thus, similar medical devices could be classified

as different items, with one requiring only a general

license and the other a validated license because the

latter has a computer that operates at a slightly higher

rate of speed or because its semiconductors are made

of a different material.

This export control process and the intricate classification system raise the level of uncertainty for medical device exporters. Whenever a validated license for

a transaction is required, an exporter cannot be sure

whether the export will be approved, in what form it

will be approved, or how long approval will take.

The eventual destination of the device raises additional questions. It is probable that export licenses will

be granted for the export to Western Europe or Japan

of a medical device incorporating controlled technology. Export of the same device to a country in Eastern Europe or to the Soviet Union may or may not

be allowed, depending on the discretionary decision

of the Commerce Department as to whether the release of the technology may hurt U.S. national security. Even if export approval is granted, conditions

may be imposed, including substantial modification

of a device in order to prevent the release of sensitive

technology. The question for the exporter is whether

a prospective buyer would be willing to accept a device that is significantly different from that which the

buyer originally intended to purchase.

Regardless of whether the export of a medical device is eventually approved, the length of time involved in the licensing process is a disincentive to export. In most cases, the Commerce Department issues

an export license in 4 to 6 weeks. This time frame,

however, rests on the assumption that the export does

not involve highly sensitive technology and is not

destined for a sensitive country such as the Soviet

Union, and that the exporter has supplied all the correct documentation to the Commerce Department. Delays occur when the exporter submits insufficient or

incomplete information or when other agencies, usually the Departments of State and Defense, exercise

their right to review an application. In such cases, delays of months and, in extreme cases, years may result.

A number of proposals currently being considered

to facilitate export while protecting national security,

such as elimination of export licenses to most Western European countries, reduction of controls in situations where identical technology is available from

other foreign sources, and reconsideration of which

technology is deemed to be militarily sensitive, may

remove many medical devices from controls. Similarly, Administration moves to ease restrictions on exports to China will open up that market to increasing

numbers of U.S. medical devices.

U.S. Government Export Promotion Activities

Department of Commerce.—Most Government export promotion activities are centered in the Department of Commerce. Among the department’s export

promotion activities are the Export Trading Company

program, the dissemination of information about

standards, the development of market research data,

and the activities of the Foreign Commercial Service.

Under the Export Trading Company Act (Public

Law 97-290) groups of U.S. exporters are able to combine their resources to aggressively seek export mar-
App. l—Governmental Regulation of International Trade in Medical Devices • 221

kets. Groups of medical device exporters or even a

single medical device manufacturer may obtain a certificate from the Department of Commerce enabling

them to engage in certain activities that would otherwise be prohibited under antitrust laws. There has been

little experience in the operation of export trading companies, and it will be some time before it can be determined whether the program will in fact significantly

promote U.S. exports. At the present time, no medical device manufacturers appear to have attempted to

establish export trading companies.

A second Commerce Department function of potential significance to the medical device industry is the

compilation by the National Bureau of Standards of

lists of applicable foreign standards. This project has

not yet been completed, but when it is, the ready availability of applicable foreign standards will be of help

to U.S. medical device exporters. There is currently

no compilation of medical device standards. FDA’s Bureau of Medical Devices publishes an annual survey

of standards for medical devices, but it simply identifies relevant standards of most major U.S. trading

partners and does not reproduce them. The actual

standards are available only from sources in the foreign country, or, in some cases, from private organizations in the United States, such as the American National Standards Institute, Inc.

The Department of Commerce also provides a variety of resources for potential exporters, including

market research and computerized lists of market opportunities. The department has, for example, commissioned detailed market surveys of the medical device markets in a variety of countries. These Country

Market Surveys include information about market

conditions, the status of foreign competitors, the major end-users, and forecasts of the markets for particular medical devices. Also included are brief reviews

of foreign government regulations. The department

also maintains lists of potential purchasers of U.S.

goods.

Although the services provided in the Department

of Commerce are not a substitute for individual market analyses by an exporter and do not eliminate the

exporter’s need for competent assistance in the foreign

market, they do provide some help, particularly to

first-time exporters to certain markets.

Department of the Treasury .—The most significant

financial export incentive provided by the U.S. Government and available to exporters of medical devices

is the “DISC” export tax system. Under the DISC provisions of the income tax code, a corporation engaged

in export trade may set up a corporation called a

Domestic International Sales Corp. (DISC), through

which it channels its export sales. It is then permitted

to defer tax on portions of the income of the DISC.

Under the complicated accounting rules applicable to

DISC taxation, the amount of income thus sheltered

varies, depending on the level of export sales made by

the DISC, but generally up to 20 percent of the income

generated by export sales can be sheltered.

The DISC system is currently under congressional

review. International criticism of the DISC system as

an illegal export subsidy persuaded the United States

to make a commitment to its foreign trading partners

to eliminate it. There are several possible replacements

for the DISC system pending before Congress.

U.S. Trade Representative.—The U.S. Trade Representative (USTR) is the principal U.S. negotiator for

international trade agreements. USTR represented the

United States at the Tokyo Round of the Multilateral

Trade Negotiations, held under the auspices of the

General Agreement on Tariffs and Trade (GATT),

which led to the development of the Standards and

Government Procurement Codes. The Standards Code

is an agreement among the signatory countries, including most major export markets for U.S. medical

devices, not to use standards as nontariff barriers (see

app. H). The Government Procurement Code is an

agreement to expand the opportunities of foreign sellers to compete for Government contracts. By seeking

to enforce U.S. rights under these agreements, and by

negotiating for an expansion of their scope, USTR can

play a role in expanding foreign markets for U.S. medical devices.

USTR also conducts bilateral negotiations to remove

specific trade barriers to U.S. goods. The issues are

usually brought to the attention of the USTR by private industry. For instance, USTR has been negotiating a reduction in Japanese medical devices trade barriers for the last year. The U.S. medical device industry

brought to the attention of USTR a number of Japanese import procedures that had the effect of significantly limiting the access of U.S. products to the Japanese market. Among these barriers were regulations

requiring chemical testing for devices, restrictions on

changes in import agents, complex procedures for approving minor device changes that do not affect health

and safety, and the generally slow process leading to

approval of medical devices. Negotiations between the

Japanese and USTR have had limited positive results,

with some restrictive procedures having been modified to accommodate U.S. concerns (see below).

Canada

The Canadian market for medical equipment, including medical devices, was approximately $440 million in 1981 (241). By 1980, imports of medical equipment had reached an estimated $391 million annually,

constituting 88 percent of the total market. By far the
222 • Federal Policies and the Medical Devices Industry

largest share of the imports, 82 percent in 1980, came

from the United States, and many of the domestic

Canadian medical device manufacturers are owned by

U.S. firms. Canada has had universal health insurance

since the early 1970s.

Import Requirements

There is no import license required for medical devices. However, under regulations issued by the Ministry of National Health and Welfare, it is illegal for

any person to import for sale any device which does

not meet the specific requirements relating to safety,

efficacy, and truthful labeling of the Canadian Food

and Drug Act or the Medical Device Regulations (255).

As in the United States, goods found to be nonconforming may be relabeled or modified by the importer

to meet Canadian requirements.

In addition, within 10 days of the first sale of a device in Canada, importers are required to provide information to the Health Protection Branch of the Ministry of National Health and Welfare regarding the

foreign manufacturer or importer, the Canadian distributor, the model number, any drugs present in the

device, statements of the uses for which the device is

being offered, and the method(s) of sterilization, if any,

recommended by the manufacturer.

Extra-oral dental X-ray equipment is subject to special import restrictions (254). Imported radiationemitting devices must comply with all applicable

standards regarding design, construction, and function. Canada will accept X-ray devices certified under

U.S. FDA performance standards.

Tariffs on medical devices now average approximately 15 percent and are expected to be reduced to

9.5 percent by 1985 under GATT commitments already made by Canada (241).

Product Approval Process

Both imported and domestically manufactured medical devices are regulated by the Health Protection

Branch of the Ministry of National Health and Welfare, which carries out laws such as the Radiation Emitting Devices Act, the National Health and Welfare Act,

the Food and Drugs Act, and the Hazardous Products

Act, which concern the types of information required

to be submitted and the timing of the submissions.

Under the Canadian product approval system, the

manufacturer or importer of a medical device must

conduct premarket tests and present the results to the

Health Protection Branch. The data must indicate the

benefits and performance results claimed for the device. In addition, at any time the manufacturer must

be prepared, if requested, to provide to the Assistant

Deputy Minister of the Health Protection Branch information on test methods and test results (255).

Only recently has the Canadian Government begun

to develop regulatory standards for medical devices.

The Bureau of Medical Devices in the Health and Protection Branch of the Ministry is concerned with the

technical and scientific aspects of medical device regulation regarding the quality, safety, and efficacy of

medical devices (241). The bureau conducts research

to allow it to enact specific safety and performance

standards for various types of medical devices and to

develop test methods to evaluate conformity with these

standards. It also tests devices for compliance with

standards, to assess manufacturer’s claims for safety

and efficacy, and to evaluate newly suspected hazards

in previously approved devices.

In addition to its scientific duties, the bureau accumulates information on sales of medical devices in

Canada and monitors recall developments in foreign

countries. When appropriate, it also initiates recalls

of imported devices.

Only a few types of medical devices are presently

subject to mandatory standards promulgated by the

bureau (241). In addition to the standards for radiation-emitting devices, there are now national standards on leakage of current from electromedical devices

and the design and operation of oxygen inhalators.

These standards tend to be similar, though not identical, to U.S. standards.

The bureau has also enacted regulations requiring

premarket review of all implantable medical devices

and submission by the manufacturer of safety and effectiveness data. It is expected that the bureau will issue

additional standards for a number of medical devices

in 1984—including labeling and packaging standards

for radioenzyme testing devices, infant incubators,

medical gas cylinders, and ozone emissions from medical devices.

Medical devices that are “new” within the definition

of the Canadian Food and Drugs Act are subject to

additional regulatory requirements first imposed in

1975 (255). At the present time, the only products that

fit this category of “new” devices are intrauterine

devices, cardiac pacemakers, prolonged-wear contact

lenses, and intraocular lenses. Even these devices are

considered new only if they have not previously been

sold by the same manufacturer in Canada, differ from

a device previously sold by the same manufacturer in

Canada, or are identical to a device previously sold

in Canada by the same manufacturer but recalled or

withdrawn from the Canadian market. To be sold in

Canada, new devices must receive a Notice of Compliance from the Health Protection Branch.

In addition, it is usually necessary for manufacturers

of certain medical devices to comply with standards
App. I—Governmental Regulation of International Trade in Medical Devices ● 223

set by the Canadian Standards Association, an independent, private body. The association has two general specifications that govern X-ray equipment and

electromedical equipment. Provincial governments enforce compliance with these standards (241).

Other Market Factors

Other than tariffs, which are temporarily somewhat

higher than in the other developed countries in this

study, the Canadian market remains remarkably free

of direct and indirect import barriers. The health care

delivery system does not discriminate overtly against

purchase or use of foreign medical devices. However,

the Canadian Federal Government has had a practice

of granting a preference to goods of Canadian origin

when making purchasing decisions. This has taken the

form of accepting bids by Canadian suppliers that are

within a specified range (5 to 15 percent) of the lowest

bid offered by a firm importing similar goods.

Some provinces, particularly Ontario and Quebec,

have adopted similar preferences for products from

within the province. Although the Federal and Provincial governments purchase most of the medical

devices sold in Canada, the effect of their procurement

policies on imports has not been as great as might have

been expected, probably because except for disposable

the Canadian medical devices industry is not well developed.

Japan

The Japanese market for all medical equipment, including medical devices, was estimated to be about

$1.24 billion in 1982 (122). The share of the Japanese

medical equipment market held by imports has in recent years been only about 23 percent, one of the

lowest percentages for any industrialized country except the United States. The United States is the largest

supplier of medical equipment in Japan, providing approximately 60 percent of all such imports in 1982.

Import Requirements

Special technical import requirements apply to

many products, including medical devices. When a device is subject to one of these technical requirements,

a firm must apply to the Ministry of International

Trade and Industry (MITI) for an import quota certificate. In addition, U.S. products that require an export license under the U.S. Export Administration Act

or are subject to other U.S. export controls must also

have an import certificate. Most medical devices are

also subject to technical inspection at the point of entry to Japan to assure that any applicable standards

have been met.

Under the Pharmaceutical Affairs Law, importation

of medical devices into Japan must be approved by

the Ministry of Health and Welfare unless the devices

bear the Japanese Industrial Standards Committee (JIS)

mark of approval (243). The term medical device includes instruments for use in the diagnosis, cure, or

prevention of disease in man or animals, or intended

to affect the structure or function of the body and

which are designated by Cabinet Order.

Two types of licenses are necessary to import a medical device. The first is a license for professional importation, a general license required of all importers,

which signifies that a company or person is qualified

to sell medical equipment in Japan. The purpose of this

licensing procedure is to ensure that each company importing medical equipment to Japan has the capability and knowledge to service the equipment and instruct purchasers in its proper use. Each office of an

importing firm must be separately licensed for professional importation. These licenses are valid for only

3 years.

Each type of medical device to be imported must

also be granted a separate product license, which is

to ensure the quality, safety, and efficacy of the device (243). To be granted a license, the device, if it has

not already received the JIS mark, must go through

a time-consuming and rigorous testing and approval

process. Virtually any modification in the design or

type of a device being imported, even if it does not

change the product’s performance, requires a repetition of the product approval process discussed below,

as though an entirely new product was being licensed.

Until August 1983, only an importer could apply

for a product license. The theory behind this requirement was that the importer, rather than the foreign

manufacturer, actually stood behind the device in Japan for product liability and all other purposes. For

this reason, transfer of a product license from one importer to another was forbidden. The effect of this requirement was to limit drastically the ability of overseas suppliers to change their Japanese distribution

agents, since switching agents required submitting a

new product license application, causing delays of 6

months to 2 years.

In response to growing pressure from European and

U.S. Government agencies (3) and trade groups, the

Japanese Ministry of Health and Welfare in April 1983

announced planned changes in the importer and product licensing process (173). The most significant modification was that, effective August 1, 1983, a foreign

manufacturer could apply for a product import license.

The foreign manufacturer must submit the same docu-
224 . Federal Policies and the Medical Devices Industry

ments and data relating to a device’s safety and efficacy

that are required of an importer applicant and designate an “in-country caretaker, ” who handles the responsibilities ordinarily imposed on a domestic manufacturer.

Approval of a foreign manufacturer’s product import application also depends on the payment of all

costs for an onsite inspection of the foreign manufacturer’s overseas facilities. Theoretically, all U.S. manufacturers importing new devices to Japan will be subject to inspection. A “grandfather clause” limits the

applicability of this new system to medical devices not

currently on the Japanese market. A recent change in

the regulations issued under the medical device law

allows product licenses to be transferred from one importer to another in certain cases.

Japan applies GATT tariffs to medical devices. The

rates now average between 6 and 8 percent and are

scheduled to decrease by 0.5 percent on average in

1984 (122). Japan has adopted the basic Customs Cooperation Council Nomenclature (CCCN) for purposes

of classifying imports, including medical devices.

Product Approval Process

Applications for approval of the product license discussed above are made to the local prefectural government and must be accompanied by the results of

clinical tests conducted in Japan (242). If the device

is identical to an already approved item or has received

the JIS mark, approval by the Pharmaceutical Affairs

Bureau is automatic. Otherwise, a minimum of two

clinical studies conducted in authoritative general or

university hospitals is required. Because tests conducted only on Japanese nationals are acceptable, U.S.

firms have to repeat clinical tests in Japan that have

already been conducted elsewhere (3).

The time elapsed between submission of an application and the receipt of final approval is a minimum

of 3 months and can be as much as a year or more

(215). The Government official responsible for the review need not inform the manufacturer in advance of

the data needed and may require additional studies and

information. As a result, considerable time elapses if

the Ministry of Health and Welfare returns applications for more data.

Another problem that has been raised during U. S.-

Japan discussions of medical device regulation is the

need to apply to local prefectural offices, which then

forward data to the Ministry of Health and Welfare.

The U.S. Government has urged Japan to allow local

prefectures to approve routine applications, such as

changes in the color and size of a product.

JIS, a part of MITI, has broad powers to establish

standards for industrial products. JIS standards are not

usually identical to the corresponding international or

U.S. standards. Although devices are not required by

law to conform to JIS standards, and some domestically manufactured items that do not conform are

actually sold in Japan, it is very difficult to import and

sell products that do not conform to JIS standards.

Foreign manufacturers can apply for permission to

attach the JIS emblem to their products under the Industrial Standardization Law (Law No. 185, 1949,

revised 1980). Permission to use the mark is given on

a plant-by-plant basis after an onsite inspection by officials of the applicable Ministry. Depending on the

nature of the medical device, permission to use the JIS

mark must be approved by MITI. JIS has promulgated

hundreds of standards relevant to medical devices

(122). The general standards are usually similar to the

standards promulgated by the International Electrotechnical Commission. Specific JIS standards have

been established for some electromedical devices including cardiographic, electroencephalographic, and

audiometric. A program is now under way to put into

place specific standards for 38 additional electromedical devices.

Under the Pharmaceutical Affairs Law, the Ministry of Health and Welfare has developed its own standards for certain medical devices such as contact lenses

and artificial heart valves for which sterilization is particularly important. Products for which Ministry

standards have been developed require for importation certification that they conform with the standards.

Obtaining this certification involves testing samples

in Japan.

Other Market Factors

Both established business practices and Government

regulation hinder the importation of medical devices

into Japan.

The Japanese Government has set up the GOTODA

Committee to study ways of bringing the Japanese certification process and standards more in line with international practice (195). The committee’s recommendations have led to Government modification of some

regulations, such as the product import license scheme

above. However, a number of regulatory barriers have

remained, such as the requirements that clinical testing

be performed on Japanese people; that electromedical

devices remain at the point of entry until they have

been inspected and approved for release; and that the

product approval process be repeated for very minor

modifications not affecting a device’s performance or

safety.

Many U.S. firms operating in Japan also believe that

the Japanese Government enforces its product licensing requirements unequally, to the disadvantage of im-
App. I—Governmental Regulation of International Trade in Medical Devices ● 225

porters. Because the Ministry of Health and Welfare

lacks a domestic enforcement arm similar to the FDA’s

field force, violations of the product licensing requirement may go undetected.

The existing system of distribution is also a stumbling

block to expansion of the import market in medical

devices. U.S. firms and their subsidiaries have generally relied on domestic sales agents to sell their products, Direct sales by importers to end-users were

unheard of until the recent changes in Japanese regulations effective August 1, 1983. Direct sales will probably remain rare for a while, given the importance of

personal ties to the market and the requirement that

foreign firms wishing to sell to an end-user must obtain a license for professional importation which involves inspection of each plant where the product is

manufactured. Such licenses, however, are not required for import sales to distributors or other firms

that resell the equipment to end-users.

Although most U.S. manufacturers of medical devices have not had Japanese subsidiaries, a growing

number of U.S. firms, including Beckman Instruments,

Inc., American Hospital Supply Corp., and Baxter

Travenol Laboratories, Inc., have set up subsidiaries

to promote Japanese sales. Using subsidiaries assures

buyers that the seller has the knowledge and ability

to give proper instruction in use of the device and to

service it after sale, both important factors in selling

very sophisticated electromedical devices.

Sales to an agent remain the most common form of

product distribution, not only for medical devices but

also for many other imported products. However, the

system of selling through agents results in one or more

markups of the device’s price, which pushes the price

of foreign products above those of comparable Japanese products.

United Kingdom

The United Kingdom has traditionally been a major market for medical devices because of its extensive and sophisticated health care system. In 1982, total

sales of medical equipment in the United Kingdom

were in excess of $600 million (52). The size of the U.K.

medical device market is linked directly to expenditures

for the nationalized health care system, which has

slowed considerably during the 1980s.

In 1982, the United Kingdom imported $537 million

of medical devices. The United States had the largest

share of the total U.K. import market for medical

devices with 28 percent, up from 25 percent in 1980

(52). It is expected that the U.S. share will continue

to increase to nearly 36 percent of total imports by

1987. Increases in medical device imports from other

major suppliers will reflect both increased competition

among foreign suppliers to maintain their sales and decreased sales by U.K. domestic suppliers. The major

new products in which U.S. suppliers are expected to

do well over the next 5 years are high-technology

items, such as laser technology, fiber optics, and

micro-surgical equipment.

Import Requirements

The general British import regulations applicable to

all imported goods do not appear to significantly impede the importation of medical devices (105). Nor are

foreign manufacturers of medical devices required to

obtain Government-issued clearances when their goods

are imported into the United Kingdom. Foreign concerns are permitted to negotiate directly with the enduser, and there is no requirement that the transaction

be reported to the Government. Imported medical devices are subject only to routine customs procedures.

As a member of the European Community, the

United Kingdom does not impose tariffs on the products of European Community member states. Therefore, members can sell medical devices in the United

Kingdom at a competitive advantage. The United

Kingdom along with many other European countries

adheres to the CCCN for the classification of medical

devices. Having a standardized category of goods

simplifies the import and export of medical devices.

British tariff duties do not impose a substantial barrier to the importation of medical devices. The duty

rates on most medical devices range from 5 to 8 percent ad valorem and are generally comparable to or

slightly below similar tariffs in the United States. Certain medical device imports, such as those intended

for training and research or for sale to nonprofit institutions may be exempted altogether from the imposition of duties.

In addition to being subject to duties imposed on

devices from non-European Community countries, all

imported medical equipment is subject to a 15-percent

value-added tax (VAT) imposed on the duty-paid

value of the goods. The VAT is imposed in order to

equalize the treatment of imported devices with those

manufactured in the United Kingdom, which are already subject to a VAT.

Product Approval Process

Although medical devices sold in the United Kingdom are not generally subject to the drug laws or to

any mandatory scheme comparable to the controls exercised by the FDA, regulations do apply to the medical device market. Many medical devices are regulated

by two divisions of the Department of Health and
226 ● Federal Policies and the Medical Devices Industry

Social Security. The Medicines Division controls the

manufacturing, licensing, clinical trial, certification,

safety, efficacy, pre-market approval, labeling, quality

control and adverse-reaction reporting of those devices

subject to the provisions of the Medicines Act of 1968,

as amended. Although the Medicines Act applies primarily to drugs, it also covers such devices as surgical sutures, dental filling substances, contact lenses,

intrauterine contraceptive devices, and certain radioactive medicinal products (174).

The Supplies, Industries, and Exports Division administers the Drug Tariff, which lists products that

may be prescribed and distributed through the National Health Service (NHS). In addition, this division sets

specific purchasing requirements for such medical

devices as X-ray equipment, hemodialysis machines,

and surgical implants (174). The activities of the division are focused on devices that the Government purchases in large volume and on products that, if found

to be defective, would pose a substantial hazard to the

public health and welfare. Through the Supplies, Industries, and Exports Division, the Government, which

is by far the largest purchaser of medical devices, routinely sets quality and safety standards for the products it purchases. These standards, adhered to by

domestic procedures, must be complied with by importers in order to sell in the U.K. market.

The Government also influences, unofficially, the

types and specifications of other medical devices

through a voluntary system of manufacturer registration that operates through the National Health Service (174), Under the control of the Scientific and Technical Branch of the Supplies, Industries, and Exports

Division, this system allows manufacturers of medical devices to voluntarily register their businesses

under certain “good manufacturing practice” guides

that have been developed in consultation with British

trade associations.

Registration certifies that equipment manufactured

by the concern meets certain safety and effectiveness

criteria. The guides cover the entire manufacturing

process, from training of personnel to packaging, labeling, and possible recall. The first guide, applicable

to sterile, single-use medical devices, became effective

in 1982. Guides are expected to be issued for numerous areas in the future.

Although NHS hospitals are not required by law to

make purchases from registered manufacturers, the

system contains incentives to encourage registration.

The Health Service Supply Council will circulate lists

of registered manufacturers along with a recommendation that products should be purchased only from

listed manufacturers. In effect, then, the Scientific and

Technical Branch’s advisory standards will guide the

purchase of medical equipment by NHS hospitals. Because these hospitals do most of the medical equipment purchasing, it will generally be good business

practice for a device manufacturer to register under

a “good manufacturing practice” guide, if one applies.

The combination of standards for Government purchases and reliance by private purchasers on those

standards acts as an unofficial regulatory scheme for

both imported and domestic medical devices sold in

the United Kingdom. The result is a degree of regulation of medical devices, that, though lacking a statutory basis, is as pervasive as that existing in almost

any other country. The “voluntary” registration procedure will soon augment the power of these indirect

controls even further.

Certain medical devices, including electrical and

radiological medical equipment, must also comply

with standards issued by the British Standards Institution (BSI) (52). These standards may pose significant obstacles to U.S. manufacturers, since compliance

with U.S. standards does not always satisfy all U.K.

requirements. In general, compliance with the standards of BSI is now as important in the sale of electrical medical devices as compliance with a standard

developed by the Supplies, Industries, and Exports

Division.

Other Market Factors

Since Government agencies purchase the vast majority of all medical devices sold in the United Kingdom, marketing strategy must be aimed at Government, rather than private, procurement. Purchases by

Government hospitals and other agencies have in the

past been made primarily at the local level, rather than

through a centralized purchasing system. This decentralized purchasing system for NHS hospitals has

resulted in hospitals’ buying equipment which may not

be exactly what they need, or paying more for equipment because they are not buying in large quantities.

In an effort to overcome these problems, NHS has

recently revised its purchasing procedure to set up 17

regional purchasing centers and a new, national Supply

Council to act as a central purchasing agency for highvolume equipment purchases (52).

France

The French market for all medical equipment was

an estimated $356 million in 1980, with imports accounting for about 70 percent of that market (286).

Exports of French medical equipment have averaged

about 80 percent of imports to France. During the last

decade, the United States replaced West Germany as
App. I—Governmental Regulation of International Trade in Medical Devices ● 227

the leading exporter of medical equipment and in 1980

provided about 24 percent of all imported medical

equipment to France.

Import Requirements

In addition to the regular documents for import, numerous medical devices require technical visas, which

permit surveillance of the quantity and price of imports (286). Technical visas are required for anesthetic

equipment, syringes and surgical supplies, special diagnostic equipment, blood transfusion apparatus, and

electrostatic units containing artificial radioactive

elements.

Tariffs on most imported medical equipment range

between 5 and 13 percent (286) and apply only to

goods outside the European Community. Under commitments made at the Tokyo Round of GATT, these

tariff rates should decrease slightly over the next few

years. France does impose a VAT of 17.6 percent on

most goods, including medical devices, regardless of

their source.

Product Approval Process

A combination of technical standards and product

approval requirements necessary for government purchases and reimbursement payments constitutes an indirect but comprehensive system of regulation. The effectiveness of this system is increased by the reliance

private parties place on official standards in making

their own purchasing decisions.

The French Pharmacopeia3 sets forth detailed purity

standards for drugs and “sterile devices, ” such as surgical dressings, sutures, certain implants, absorbent

cotton, and a variety of plastic products. Pharmacopoeia requirements technically apply only to products that are sold to public institutions or to products

that claim to comply with the Pharmacopoeia. However, their role in practice is far broader, since private

purchasers also rely on compliance with Pharmacopoeia

requirements as an indication of quality (164).

For certain medical devices that are to be sold to

public institutions, French law requires official government approval through “homologation.” The Commission d’Homologation periodically lists certain categories of devices that must be approved before they

can be purchased by a public institution. Manufacturers must formally apply to the commission, which

requires submission of test reports by the manufac3The French Pharmacopoeia has semiofficial status in France, under the

authority of the Ministry of Public Health. Although its definitions, procedures, and standards do not have the same force and effect, as for example,

FDA regulations in the United States, it is used as a guideline to identify health

and safety violations associated with various drugs and medical devices.

turer. At the end of the process, a proposal is made

to the Ministry of Health, which issues an approval

decree and a homologation number (164). Many manufacturers submit their products to the homologation

process even when they are not required to do so, because products with official approval have a larger

market.

Certain medical devices sold to public agencies are

also subject to technical standards developed with the

cooperation of industry and the Association Francaise

du Normalization (AFNOR), a governmental standards body. These standards are imposed by various

agencies of the national government (286). These products may not be imported unless the Ministère de l’lndustrie, du Commerce et de l’Artisunat has certified

that they conform with the applicable technical standards. If the relevant standards are developed or administered by a department other than the Ministère

de l’Industrie, initial testing and approval of the device will be done by that department.

The difference between the AFNOR standards and

those under the homologation process is that the

AFNOR standards cover very technical matters such

as the electrical workings of a device, while the homologation process is a much more general product approval process dealing with both electrical and nonelectrical devices. Compliance with AFNOR standards

can be useful in marketing a product. Conformity is

shown by an “NF” mark on the label, which can only

be used with permission of AFNOR after testing of the

product and inspection of the manufacturing premises.4

Other Market Factors

Government procurement is a very important factor in the French medical device market, with purchases by public hospitals accounting for the largest

segment of the market. A central purchasing group

representing public hospitals, the Union de Groupements d’Achats Publiques, accounts for over one-half

of the medical equipment purchases by all public hospitals (376). Acceptance by this group can assure a

product’s success, particularly since private purchasing decisions tend to follow government procurement

decisions.

Government purchases are made in one of three

ways: through privately negotiated contracts, through

competitive bidding, and through bidding where factors other than price are considered. But despite

France’s adherence to the Agreement on Government

Procurement under GATT, a 1975 “Buy French” policy does apply to purchases of numerous products—

including external blood collection systems, hyperbaric

4See Exporters’ &cyc]opec/ia, at 2:481-482 (105).
228 • Federal Policies and the Medical Devices Industry

chambers, body scanners, and artificial kidney machines (286). The requirement for Ministry of Public

Health “advice” on purchases of “innovative” equipment by the public sector (previously limited to “heavy

equipment”) often takes the form of approved lists of

suppliers.

In addition, an effort is being made to strengthen

the capabilities of regional health authorities for providing advice on contemplated purchases. Such “advice” is unlikely to favor U.S. suppliers if viable local

alternatives exist, or where a manufacturer is a significant local employer. Indeed, U.S. manufacturers have

been informed that new products will not be approved

by the French authorities for purchase where there is

a competitive French-manufactured device (284).

France also requires companies importing diagnostic products to set up a quality control laboratory in

France to recheck every shipment, regardless of whether it has undergone quality control audits in the country of origin. No shipment of medical devices will be

licensed without testing in a Government-approved

laboratory (444).

Federal Republic of Germany

In 1980, sales of medical equipment and supplies in

the Federal Republic of Germany totaled more than

$1.5 billion (188). In 1979, the United States was the

leading foreign supplier of medical equipment with 25

percent of imports (377).

Import Requirements

Products of European Community, Western European, and developing countries are not subject to import duties (188). Tariff rates applicable to medical

equipment from other countries average 6 to 9 percent, with a maximum of about 11 percent. Most imports are subject to a VAT of 13 percent, similar to

the VAT levied on domestically manufactured products. Some imported manufactured products are subject to special excise taxes in addition to the “import

equalization tax. ” Foreign exporters to West Germany

who must pay both the tariff and the “import equalization tax” face a significant disadvantage (216).

Product Approval Process

Regulation of medical devices is similar to that existing in the United States prior to the passage of the

Medical Device Amendments of 1976, with regulation

of some products as an outgrowth of the regulation

of pharmaceuticals. The 1976 Law on the Reform of

Drug Legislation pertains to “fictitious drugs, ” which

include devices containing a drug, devices to be introduced into the body, dressings and surgical sutures,

and diagnostic products (94). Specific regulations have

been promulgated to govern manufacture, licensing,

clinical trials, reporting of adverse effects, and liability

for damage caused by drugs.

Although fictitious drugs are not now subject to

these regulations, the regulations could be extended

to them in the future. Under the Drug Reform Law,

the government also has a number of enforcement

tools that can be used against regulated devices considered misleadingly labeled, unsafe, or ineffective.

Two provisions of the law are of special interest to

importers. First, surgical suture material and certain

diagnostic products may be imported outside the European Community countries only if the importer obtains certification from a competent authority of the

manufacturing country (such as FDA in the United

States) that the World Health Organization’s good

manufacturing practices have been adhered to or that

the import is in the interest of the general public. West

Germany is in the process of adopting its own GMP

regulations for the pharmaceutical industry, and these

will apply to manufacturers of fictitious drugs.

Second, the law requires any person who markets

a medical device that comes under the Drug Reform

Law to maintain a place of business within West Germany. The European Community recently ruled that

this requirement is illegal and has asked that it be abolished, but its future is uncertain.

Although the Drug Reform Law covers a relatively

small segment of the medical device industry, a much

larger segment is indirectly regulated. Regulations

issued under the German General Technical Law require that the manufacturer of technical medical equipment is in proper condition and that either the manufacturer or an expert has subjected the devices to final

inspection (192).

Test protocols may be required from the manufacturer for certain types of equipment, and testing must

be carried out at one of 34 designated institutions.

Testing for most medical devices is voluntary, but is

often performed because it has some commercial value

for the manufacturer. However, proposals have been

circulating in West Germany to make testing under this

law mandatory for all electromedical devices.

Regulation of medical devices also occurs on a piecemeal basis through the work of the Deutsches Institut

Fur Normung (DIN), the official standards body in

West Germany. DIN has developed standards in such

areas as the testing, storage, labeling, and packaging

of products, and the materials, dimensions, and tolerances to be used in manufacturing for a large number

of medical devices. Among the medical items for which

standards exist are surgical dressings, implants, and

transfusion and hematological equipment. Although
App. l—Governmental Regulation of International Trade in Medical Devices ● 229

compliance with an applicable DIN standard is not required by law, in practice it can be a major advantage in the marketplace to have a DIN mark of approval on a product. Moreover, much interpretation

of DIN standards is done in practice by West German

test laboratories whose approval is very important for

marketing a product in West Germany (458).

West Germany has a pharmacopoeia, but with only

limited applicability to medical devices. Its main focus

is drugs and only a few medical devices, such as surgical sutures and dressings, are included.

Other Market Factors

West Germany is a signatory to the GATT Agreement on Government Procurement. Although government spending represents a substantial portion of all

health care expenditures, purchases of medical devices

are for the most part decentralized without the direct

involvement of Government agencies. In practice, the

chief physician in a hospital or in one of its departments makes all purchasing decisions. The major exception involves purchases of $75,000 or more by

university clinics. Such purchases must be approved

by the German Research Association. There is no official “Buy German” policy, but the tendency of publicly financed health care institutions is to purchase

West German products.

Mexico

The market for medical equipment in Mexico is

small but growing. Approximately $44.2 million was

spent during 1980 on medical equipment, including

medical devices (28). Imports account for nearly 85

percent of all purchases of medical equipment. The

United States is the largest exporter, with 38 percent

of the market in 1980. The Federal Republic of Germany (18 percent in 1980) and France (9 percent in

1980) are closest U.S. competitors. Devices for which

production is labor-intensive are generally supplied domestically, while devices that require highly technological processes are often imported.

Import Requirements

The Mexican system of import control involves a

dual scheme of licensing and tariffs (105). Importers

may obtain a license by applying to the Ministry of

Commerce. The request is considered by one of 13

committees that specialize in a particular portion of

the tariff or by a special committee that considers

license requests by Government agencies. Requests are

usually acted on within 2 weeks. Imports by government agencies must be approved in advance by the

Public Sector Imports Committee, and approval will

be withheld if a domestic product is available which

is reasonably competitive in price and quality.

Mexico maintains no special import requirements

for most medical devices. One exception to this is that

all devices to be physically connected to a patient require import permits from the Ministry of Industry and

Commerce and the Ministry of Health and Assistance

(378). However, these permits are neither difficult nor

costly to obtain.

The majority of medical devices imported into Mexico are subject to tariffs which range from 2 to 35 percent (28). The median tariff is in the 10- to 15-percent

range, somewhat higher than other countries in this

study. The Mexican tariff generally follows CCCN.

Mexico is not a signatory to the GATT. However, the

only countries with preferential tariffs are other members of the Latin America Integration Association

(Argentina, Bolivia, Brazil, Colombia, Chile, Ecuador,

Paraguay, Peru, Uruguay, and Venezuela) (378).

Product Approval Process

There is no specific system of product approval for

medical devices under Mexican law. Certain devices,

however, require approvals from Mexican commissions that act as counterparts to U.S. utility commissions. For example, all electrical devices must be approved by the Federal Electricity Commission, a stateowned corporation, and equipment incorporating

radioactive materials must receive approval from the

Nuclear Energy Institute (378). There are also no official standards governing the design or use of medical

equipment in Mexico. Medical products, for the most

part, can be brought directly into Mexico without any

preimport procedures.

Other Market Factors

The size of the Mexican medical device market and

the import share of that market are limited by a number of factors. First, over 70 percent of all health care

expenditures in Mexico are Government-controlled

(28). The emphasis of the two major Government

agencies involved in the provision of health-related

services, the Institute for Social Security and the Secretariat of Health and Security, and of Mexican health

care providers in general, is on the provision of basic

health care services. As a consequence, there is a very

limited market for sophisticated high-technology medical equipment, such as CT scanners and cardiac diagnostic equipment, in which the U.S. medical device

industry is particularly strong.

25-406 0 - 84 - 1 6
230 ● Federal Policies and the Medical Devices Industry

Mexican governmental purchasing practices evidence a strong preference for domestically produced

items. The Government will procure medical equipment from foreign manufacturers only when the equipment cannot be domestically supplied. Indeed, the

Government has a “closed border” policy under which

it will ban imports of products that compete directly

with goods manufactured in Mexico, including those

manufactured by the Mexican subsidiary of a foreign

corporation. The effect of this policy on U.S. imports

has not, so far, been great.

Finally, there is a highly developed system of import agents who take responsibility for obtaining

licenses and negotiating with foreign suppliers. The

agents arrange for the import of a good and supply

the ultimate end-user. Direct sales to end-users, although not rare, are not significant in volume when

compared either to sales to import agents or those

made directly to the Government.

The medical devices market has also been affected

by the foreign exchange difficulties that Mexico is currently experiencing. In late 1982, exchange controls

were placed on all foreign remittances from Mexican

banks. These controls include Government approval

of import contracts requiring payment outside of Mexico, even for purchases by Government agencies.
Appendix J.—Glossary of Acronyms and Terms

Glossary of Acronyms

AAMI

AART

ACRS

AFNOR

ANSI

AOA

ASTM

BMD

BSI

CABG

CAPD

CCCN

CDC

CEN

CENELEC

CFR

CHAMPUS

CID

CLIA

CLMA

CON

CPR

CSA

CT

DEN

DHHS

DHSS

DIN

DISC

DME

DOC

DRGs

ERTA

— Association for the Advancement

of Medical Instrumentation

— American Association of Respiratory Therapists

— Accelerated Cost Recovery System

— Association Francaise de Normalisation

— American National Standards Institute, Inc.

— American Osteopathic Association

— American Society for Testing and

Materials

— Bureau of Medical Devices

(Canada)

— British Standards Institution

— coronary artery bypass graft

— continuous ambulatory peritoneal

dialysis

— Customs Cooperation Council Nomenclature

– Centers for Disease Control (PHS)

— European Committee for Standardization

— European Committee for Electrotechnical Standardization

— Code of Federal Regulations

— Civilian Health and Medical Program of the Uniformed Services

— commercial item description

— Clinical Laboratory Improvement

Act

— Contact Lens Manufacturers Association

— Certificate of need

— customary, prevailing, and reasonable

— Canadian Standards Association

— computed tomography

– Device Experience Network (FDA)

— Department of Health and

Human Services

— Department of Health and Social

Security (United Kingdom)

— Deutsches Institut fur Normung

— Domestic International Sales

Corp.

— durable medical equipment

— Department of Commerce

— diagnosis related groups

— Economic Recovery Tax Act of

1981

ESRD

FDA

GAO

GATT

HCFA

HIDI

HIMA

HMO

IDE

IEC

IFAC

IND

IV

IPA

IPPB

IRS

ISO

ITA

IUD

JCAH

JIS

MEDIPP

MITI

NBS

NCCLS

NCI

NFPA

NHLBI

NHS

NIADDK

NIH

— end-stage renal disease

— Food and Drug Administration

(PHS, DHHS)

– General Accounting Office (U.S.

Congress)

— General Agreement on Tariffs and

Trade

-- Health Care Financing Administration (DHHS)

— Health-Care Instrument and Device

Institute

— Health Industry Manufacturers’

Association

— health maintenance organization

— investigational device exemption

— International Electrotechnical Commission

— Industry Functional Advisory

Committee (DOC)

— investigational new drug

— intravenous

— individual practice association

— intermittent positive pressure

breathing

— Internal Revenue Service

— International Organization for

Standardization

— International Trade Administration

(DOC)

— intrauterine device

— Joint Commission on Accreditation

of Hospitals

– Japanese Industrial Standards

— Medical District Initiated Program

Planning

— Ministry of International Trade

and Industry (Japan)

— National Bureau of Standards

(DOC)

— National Committee on Clinical

Laboratory Standards

– National Cancer Institute (NIH)

— National Fire Protection Association

— National Heart, Lung, and Blood

Institute (NIH)

— National Health Service (United

Kingdom)

— National Institute of Arthritis,

Diabetes, Digestive, and Kidney

Diseases (NIH)

– National Institutes of Health (PHS,

DHHS)

231 <
232 • Federal Policies and the Medical Devices Industry

NMR – nuclear magnetic resonance

NSF – National Science Foundation

OEA – Office of Export Administration

(DOC)

OHTA – Office of Health Technology (PHS,

DHHS)

OIML – International Organization for

Legal Metrology

OMB – Office of Management and Budget

OTA — Office of Technology Assessment

(U.S. Congress)

PHS – Public Health Service, DHHS

PMAA – premarket approval application

PRO — peer review organization

PSRO – Professional Standards Review Organization

R&D research and development

Rehab R&D - Rehabilitation Research and DevelSBIC

SBIR

SIC

TEFRA

TÜV

UCR

UL

U.S.C.

USTR

VA

VAMKC

VAREC

VAT

VDE

WHO

YAG

opment

— Small Business Investment Corp.

— Small Business Innovation Research

— Standard Industrial Classification

— Tax Equity and Fiscal Responsibility Act of 1982

— Technischer Uberwachungs Verein

— usual, customary, and reasonable

charges

— Underwriters Laboratories, Inc.

— United States Code

— U.S. Trade Representative

— Veterans Administration

— Veterans Administration Marketing

Center

— Veterans Administration Rehabilitation Engineering Center

— value added tax

— Verband Deutscher Elektrotechniker

— World Health Organization

— yttrium aluminum garnet

Glossary of Terms

Applied research: Investigation whose objective is to

gain knowledge or understanding necessary for

determining the means by which a recognized and

specific need may be met.

Basic research: Original investigation whose objective

is to gain fuller knowledge or understanding of the

fundamental aspects of phenomena and of observable facts without specific applications in mind.

Capital costs: Expenditures for plant and equipment

used in providing a service. Under Medicare’s prospective hospital payment system established by the

Social Security Amendments of 1983 (Public Law

98-21), hospitals’ capital costs (depreciation, interest, and return on equity to for-profit institutions)

are treated as passthroughs (i. e., are not subject to

the new system’s controls).

Certificate of need (CON): A State regulatory planning mechanism encouraged by the National Health

Planning and Resources Development Act (Public

Law 93-641) to control expenditures for and distribution of expensive medical care facilities and

equipment. CON applications are reviewed by local

health systems agencies, which recommend approval or disapproval to State health planning

agencies.

Class 1: One of three regulatory classes set up by the

1976 Medical Device Amendments (Public Law 94-

295). Class I, general controls, contains devices for

which general controls authorized by the act are sufficient to provide reasonable assurances of safety

and effectiveness. Manufacturers of Class I devices

must register their establishments and list their devices with the Food and Drug Administration (FDA),

notify FDA before marketing a device, and conform

to good manufacturing practices.

Class II: The regulatory class of devices for which general controls are considered insufficient to assure

safety and effectiveness and information exists to

establish performance standards.

Class III: The regulatory class of devices for which

Class I general controls are insufficient to ensure

safety and effectiveness, information does not exist to establish performance standards, and the

device supports life, prevents health impairment,

or presents a potentially unreasonable risk of illness

or injury.

Conditions of participation: Requirements that a provider must meet in order to be allowed to receive

payments for Medicare patients. An example is

the requirement that hospitals conduct utilization

review.

Development: Systematic use of the knowledge or understanding gained from research in the design and

development of prototypes and processes.

Device type: All products of a particular type or a

grouping of separate types of devices that are

similar, as categorized by FDA. FDA has classified

device types according to the potential risk posed

by their use and the degree of regulation required.

Diagnosis related groups (DRGs): Groupings of diagnostic categories drawn from the International

Classification of Diseases and modified by the presence of a surgical procedure, patient age, presence

or absence of significant comorbidities or complica-
App. J—Glossary of Acronymns and Terms • 233

tions, and other relevant criteria. DRGs are the

case-mix measure mandated for Medicare’s prospective hospital payment system by the Social Security Amendments of 1983 (Public Law 98-21).

DRG payment: The system of prospective payment for

inpatient services by Medicare which was mandated

by the Social Security Amendments of 1983.

Good manufacturing practices: Requirements regarding the manufacturing, packing, storage, and installation of devices required under the Medical Device

Amendments of 1976 and applicable to all three regulatory classes of devices.

Investigational device exemption (IDE): A regulatory

category and process under which FDA permits limited use of an unapproved medical device in controlled settings for the purpose of collecting data

on safety and effectiveness. This information may

subsequently be used in support of a premarketing

approval application.

Medical device: Any instrument, apparatus, or similar or related article that is intended to prevent,

diagnose, mitigate, or treat disease or to affect the

structure or function of the body.

Medical technology: The drugs, devices, and medical

and surgical procedures used in medical care, and

the organizational and support systems within

which such care is provided.

Nuclear magnetic resonance (NMR) imaging: A diagnostic imaging modality that uses radiowaves and

powerful magnetic fields rather than ionizing radiation.

Orphan product: Defined by the Orphan Drug Act of

1983 (Public Law 97-414) as drugs and medical

devices for rare diseases or conditions.

Peer review organizations (PROS): Physician organizations established by the Tax Equity and Fiscal

Responsibility Act of 1982 (Public Law 97-248) to

replace Professional Standards Review Organizations. Hospitals are mandated to contract with

PROS to review quality of care and appropriateness of admissions and readmissions. PROS are also

termed utilization and quality control peer review

organizations.

Postamendments device: A medical device first marketed after May 1, 1976, when the Medical Device

Amendments took effect.

Preamendments device: A medical device marketed

before May 1, 1976, when the Medical Device

Amendments took effect.

Premarket approval application (PMAA): An application to FDA for approval to market a new device.

The sponsor of the device must submit to FDA information to document its safety and effectiveness

before the drug may be marketed.

Procedure (medical or surgical): A medical technology involving any combination of drugs, devices,

and provider skills and abilities. Appendectomy, for

example, may involve at least drugs (for anesthesia), monitoring devices, surgical devices, and the

skilled actions of physicians, nurses, and support

staff.

Professional Standards Review Organizations (PSROs):

Community-based, physician-directed, nonprofit

agencies established under the Social Security Amendments of 1972 (Public Law 92-603) to monitor the

quality and appropriateness of institutional health

care provided to Medicare and Medicaid beneficiaries.

Prospective payment: Payment for medical care on the

basis of rates set in advance of the time period in

which they apply. The unit of payment may vary

from individual medical services to broader categories, such as hospital case, episode of illness, or

person (cavitation).

Standard Industrial Classification (SIC) codes: A categorization of data on products and companies that

is used by the U.S. Department of Commerce. Establishments (plants) are assigned to SIC “industries” on the basis of their primary line of business.

However, SIC data on shipments of a specific product include all shipments of the relevant product,

regardless of the “industry” in which the producing establishment is classified.

Substantially equivalent device: A device first marketed after the 1976 Medical Device Amendments

that FDA has found to be similar to a device already

being marketed. To be found substantially equivalent, a postamendments device need not be identical to a preamendments device, but must not differ markedly in materials, design, or energy source.

Third-party payment: Payment by a private insurer

or government program to a medical provider for

care given to a patient.

Transitional devices: Devices that were regulated as

new drugs before enactment of the 1976 Medical

Device Amendments.
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U.S. Department of Commerce, Bureau of

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U.S. Department of Commerce, Bureau of

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U.S. Department of Commerce, Bureau of Industrial Economics, Office of Producer Goods,

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U.S. Department of Commerce, Bureau of Industrial Economics, Office of Producer Goods,

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U.S. Department of Commerce, Bureau of Industrial Economics, Office of Producer Goods,

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Imports of Selected Commodities by Country,

January-September 1982,” unpublished, Washington, DC, Nov. 26, 1982.

375.

376.

377.

378.

379.

380.

381.

382.

383.

384.

385.

386.

387.

388.

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U.S. Department of Commerce, International

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U.S. Department of Commerce, Patent and

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U.S. Department of Commerce, Patent and

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U.S. Department of Health and Human Serv-
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U.S. Department of Health and Human Services, National Institutes of Health, Office of Program Planning and Evaluation and the Division

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U.S. Department of Health, Education, and
252 • Federal Policies and the Medical Devices Industry

410.

411.

412.

413.

414.

415.

416.

417.

418.

419.

420,

421.

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U.S. Department of the Treasury, Office of Tax

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U.S. National Science Foundation, Federal

422.

423.

424.

425.

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430.

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432.

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U.S. National Science Foundation, Research and

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U.S. NTational Science Foundation, “Survey of

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1980.

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U.S. Veterans Administration, Department of

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U.S. Veterans Administration, Department of

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U.S. Veterans Administration, Office of Planning and Program Evaluation, Rehabilitative

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254 ● Federal Policies and the Medical Devices Industry

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Index
Index ——

American Association of Bioanalysts, 55

American Hospital Supply Corp., 29

American Osteopathic Association, 138

California, 66

Canada, 36

characteristics of the medical devices industry, 17-37

concentration, 28-31

diversity in products, 22

growth, 17-22

innovation, 31-35

changes in the clinical laboratory, 32

how ophthalmology has changed, 33

international competitiveness of U.S. medical devices,

35

manufacturers, 25-28

Congress:

House Committee on Energy and Commerce, Subcommittee on Oversight and Investigations, 97, 105

Senate Committee on Veterans Affairs, 3

Senate Labor and Human Resources Committee, 3

consensus standards related to international trade, 204

Contact Lens Manufacturers Association (CLMA), 107

Cooper, Theodore, 98

database of Venture Economics, Inc., on sources of

financial capital, 197

Department of Commerce, 22, 163

Department of Defense, 14

Department of Energy, 80

Department of Health and Human Services, 11, 49, 88

diagnosis related groups (DRGs), 7, 8, 48, 50

Dingell, Rep. John, 105

European Economic Community, 36

Food and Drug Administration (FDA), 3, 4, 5, 21, 44

classification of medical devices, 8, 103, 104, 105

investigational device exemption (IDE), 44

regulation of medical devices, 8-10, 97-133

General Accounting Office, 97

General Services Administration, 14

governmental regulation of international trade, 216

Health Care Financing Administration (HCFA), 44, 53,

60, 66, 138

Health Care Instrument and Device Institute (HIDI),

New York, 91

health maintenance organizations (HMOs), 64, 65

Idaho, 144

IMS America, Ltd., 22, 29

Indiana, 48

innovative process in the medical devices field, 186-190

intermittent positive pressure breathing (IPPB), 45, 46

Internal Revenue Service (IRS), 21

Joint Commission on Accreditation of Hospitals, 138,

139

Japan, 36

Johnson & Johnson, 29

legislation:

Drug Amendments of 1962, 97

Economic Recovery Act, 84

Employee Retirement Income Security Act, 84

Federal Food, Drug, and Cosmetic Act, 4, 5, 97

Medical Device Amendments of 1976, 3, 4, 5, 8, 9,

14, 44, 97

National Health Planning and Resources Development

Act of 1974, 12, 138, 151

Omnibus Budget Reconciliation Act of 1980, 60, 66

Orphan Drug Act of 1983, 11, 88

Radiation Control for Health and Safety Act of 1968,

98

Small Business Innovation Development Act, 86

Social Security Amendments of 1983, 142

Louisiana, 144

Maryland, 48

Metatech Corp., 87

Minnesota, 144

National Institutes of Health (NIH), 5, 11, 7 9

National Science Foundation (NSF), 78

New Jersey, 48

New Mexico, 144

New York, 48, 91, 150

nuclear magnetic resonance (NMR) imaging, 82

patent policy regarding medical devices, 191-195

payment policies for health care and medical devices, 6,

41-73

financial relationship between the third-party payer

and providers, 63-65

per capita payment systems, 64

public systems, 63

policy options, 65-73

hospital payment, 70

payment for devices used in the home, 67

payment for laboratory testing, 66

payment for physicians’ services, 68

systemwide reforms, 72

third-party coverage of medical devices, 43-45

third-party payment and the demand for medical

devices, 45-63

hospital payment, 47

Medicare’s DRG hospital payment system, 48

payment for

52

payment for

payment for

parenteral

payment for

ambulatory clinical laboratory services,

durable medical equipment, 55

home health care services, 59

and enteral nutrition therapy, 62

medical devices used in the home, 54

257
258 ● Federal Policies and the Medical Devices Industry

payment for physicians’ services, 51

Pharmaceutical Manufacturers Association, 31

Professional Standards Review Organizations (PSROs),

11, 12, 137, 140, 142

regulation by FDA, 97-133

discussion and conclusions, 117

impact of the amendments on medical device firms,

121

postmarketing controls, 120

regulation of intermediate classes of devices, 120

regulation of preamendments Class 111 devices and

their postamendments equivalents, 118

scope of medical devices subject to regulation, 118

implementation of the medical device law, 102

classification of devices, 105

good manufacturing practices, 107

investigational device exemptions, 111

performance standards, 107

postmarketing surveillance, 114

premarket approval, 112

premarket notification, 103

reclassification of devices, 107

policy options, 126

assistance to small manufacturers, 132

postmarketing monitoring and controls, 132

regulation of Class II, or intermediate, devices, 131

regulation of preamendments devices and their

postamendments equivalent, 128

scope of medical device regulation, 127

regulation of the providers of medical devices, 11,

137-154

Federal regulation, 137-145

health planning regulations, 143

under Medicare, 137

State regulation, 145-151

certificate-of-need laws (CON), 147-151

legislative activity in health planning, 1983

Iicensure of facilities and personnel, 145

research and development policies, 11, 77-94

Federal support for orphan devices, 88-90

wheelchairs, 90

policy options, 92-94

Small Business Innovation Research (SBIR) program,

86-88

sources of support, 79

. .

Federal support, 79, 81, 82, 83

private sources of funds, 80

State and local initiatives, 91-92

trends in medical devices R&D, 78-79

Small Business Innovation Research (SBIR) program, 11,

86-88

Standard Industrial Classification (SIC) codes, 17-30, 36,

37, 78

State certificate-of-need (CON) laws, 12, 13, 143, 144,

145, 147-154

tax policy and R&D, 199

U.S. Public Health Service, 14, 44

Veterans Administration (VA), 3, 4, 5, 6, 42

policies regarding medical devices, 13, 157-176

adoption and use, 169-172

influence of social, political, and economic factors, 170

rehabilitative devices, 169

strategic planning, 171

discussion and policy options, 173-176

procurement, 174

research and development, 173

testing and evaluation, 173

overview of health care system, 157-160

veteran patient population, 158

procurement and supply, 166-169

central procurement by the VA marketing center,

166

procurement by VA medical centers, 168

research and development, 160-162

rehabilitation research and development service,

161

VA prosthetics center, 161

testing and evaluation, 162-166

commercially available equipment and supplies,

165

commercially available rehabilitative devices, 163

prototype rehabilitative devices, 162

VA Marketing Center, Hines, IL, 83

West Germany, 36

U.S. GOVERNMENT PRINTING OFFICE : 1984 0 - 25-406