a

GAO

United States Government Accountability Office

Report to the Chairman, Subcommittee 

on Health, Committee on Ways and 

Means, House of Representatives

September 2004 MEDICARE

Information Needed to 

Assess Adequacy of 

Rate-Setting 

Methodology for 

Payments for Hospital 

Outpatient Services

GAO-04-772
www.gao.gov/cgi-bin/getrpt?GAO-04-772.

To view the full product, including the scope 

and methodology, click on the link above. 

For more information, contact A. Bruce 

Steinwald at (202) 512-7119. 

Highlights of GAO-04-772, a report to the 

Chairman, Subcommittee on Health, 

Committee on Ways and Means, House of 

Representatives. 

September 2004

MEDICARE

Information Needed to Assess Adequacy 

of Rate-Setting Methodology for 

Payments for Hospital Outpatient 

Services 

Under the Medicare hospital 

outpatient prospective payment 

system (OPPS), hospitals receive a 

temporary additional payment for 

certain new drugs and devices 

while data on their costs are 

collected. In 2003, these payments 

expired for the first time for many 

drugs and devices. To incorporate 

these items into OPPS, the Centers 

for Medicare & Medicaid Services 

(CMS) used its rate-setting 

methodology that calculates costs 

from charges reported on claims by 

hospitals. At that time, some drug 

and device industry representatives 

noted that payment rates for many 

of these items decreased and were 

concerned that hospitals may limit 

beneficiary access to these items if 

they could not recover their costs. 

GAO was asked to examine 

whether the OPPS rate-setting 

methodology results in payment 

rates that uniformly reflect 

hospitals’ costs for providing drugs 

and devices, and other outpatient 

services, and if it does not, to 

identify specific factors of the 

methodology that are problematic. 

GAO recommends that the 

Administrator of CMS collect data 

on excluded claims and analyze 

variation in hospital charge setting 

to determine if the OPPS payment 

rates uniformly reflect hospitals’ 

costs of providing outpatient 

services, and, if they do not, to 

make appropriate changes to the 

methodology. CMS stated that it 

will consider GAO’s 

recommendations. 

The rate-setting methodology used by CMS may result in OPPS payment rates 

for drugs, devices, and other services that do not uniformly reflect hospitals’ 

costs of providing those services. Two areas of the methodology are particularly 

problematic. The hospital claims for outpatient services that CMS uses to 

calculate hospitals’ costs and set payment rates may not be a representative 

sample of all hospital outpatient claims. For Medicare payment purposes, an 

outpatient service consists of a primary service and the additional services or 

items associated with the primary service, referred to as packaged services. 

CMS has excluded over 40 percent of multiple-service claims, claims that include 

more than one primary service along with packaged services, when calculating 

the cost of all OPPS services, including those with drugs and devices. It 

excludes these multiple-service claims because, when more than one primary 

service is reported on a claim, CMS cannot associate each packaged service with 

a specific primary service. Therefore, the agency cannot calculate a total cost 

for each primary service on that claim, which it would use to set payment rates. 

The data CMS has available do not allow for a determination of whether 

excluding many multiple-service claims has an effect on OPPS payment rates. 

However, if the types or costs of services on excluded claims differ from those 

on included claims, the payment rates of some or all services may not uniformly 

reflect hospitals’ actual costs of providing those services. In addition, in 

calculating hospitals’ costs, CMS assumes that, in setting charges within a 

specific department, a hospital marks up the cost of each service by the same 

percentage. However, based on information from 113 hospitals, GAO found that 

not all hospitals use this methodology: charge-setting methodologies for drugs, 

devices, and other outpatient services vary greatly across hospitals and across 

departments within a hospital. CMS’s methodology does not recognize 

hospitals’ variability in setting charges, and therefore, the costs of services used 

to set payment rates may be under- or overestimated. 

Number and Percentage of Hospitals that Reported Methods to Mark Up Drug and Device 

Charges, 2003 

 Drugs Devices 

Number Percentage Number Percentagea

Same percentage for all items 40 43 39 46

Graduated percentage, higher for 

low-cost items 33 36 39 46

Graduated percentage, lower for lowcost items 6 7 4 5

Other 13 14 3 4

Source: GAO. 

a

Percentage of total hospitals does not total 100 percent due to rounding. 
Page i GAO-04-772 Medicare Hospital Outpatient Payments

Contents

Letter 1

Results in Brief 5

Background 7

Payment Rates Were Generally Lower for Separately Paid Drugs, but 

Cannot Be Evaluated for Packaged Drugs and Devices 11

No Type of Hospital Provided a Disproportionate Number of 

Services Associated with Certain Drugs and Devices 14

Payment Rates May Not Uniformly Reflect Hospitals’ Costs 15

Conclusions 18

Recommendations for Executive Action 19

Agency and External Reviewer Comments and Our Evaluation 19

Appendixes

Appendix I: Scope and Methodology 23

Appendix II: Summary of Hospital Charge-Setting Methodologies 26

Appendix III: Comments from the Centers for Medicare & Medicaid 

Services 28

Appendix IV: GAO Contact and Staff Acknowledgments 33

GAO Contact 33

Acknowledgments 33

Tables Table 1: Payment Rates for Drug Administration APCs, 

2002-2003 13

Table 2: Percentage of Medicare Outpatient Services by Type for All 

Hospitals and for Hospitals with Various 

Characteristics 15

Table 3: Number and Percentage of Hospitals that Reported 

Methods for Setting Base Charges for Clinic Visit Services, 

2003 26

Table 4: Number and Percentage of Hospitals that Reported 

Methods to Mark Up Drug and Device Charges, 2003 27

Figures Figure 1: Example of a Single-Service Claim with Packaged 

Services 9

Figure 2: Example of a Multiple-Service Claim with Packaged 

Services 9
Contents

Page ii GAO-04-772 Medicare Hospital Outpatient Payments

This is a work of the U.S. government and is not subject to copyright protection in the 

United States. It may be reproduced and distributed in its entirety without further 

permission from GAO. However, because this work may contain copyrighted images or 

other material, permission from the copyright holder may be necessary if you wish to 

reproduce this material separately.

Abbreviations

AAMC Association of American Medical Colleges 

ACCC Association of Community Cancer Centers 

AdvaMed Advanced Medical Technology Association

AHA American Hospital Association

APC ambulatory payment classification

AWP average wholesale price

BIO Biotechnology Industry Organization 

CMS Centers for Medicare & Medicaid Services

FAH Federation of American Hospitals 

HCPCS Healthcare Common Procedure Coding System

PhRMA Pharmaceutical Research and Manufacturers of America

PPS prospective payment system

OPPS outpatient prospective payment system
Page 1 GAO-04-772 Medicare Hospital Outpatient Payments

United States Government Accountability Office

Washington, D.C. 20548

A

September 17, 2004 Letr

The Honorable Nancy L. Johnson

Chairman

Subcommittee on Health 

Committee on Ways and Means 

House of Representatives

Dear Chairman Johnson:

Since 2000, hospitals have been paid fixed, predetermined amounts under a 

prospective payment system (PPS) for outpatient services delivered to 

Medicare beneficiaries. By paying hospitals under a PPS, Medicare seeks 

to encourage them to operate efficiently, as they retain the difference if 

their payments exceed their costs of providing necessary services. 

However, unlike most other Medicare PPSs, where each payment amount is 

designed to cover the combined costs of a large bundle of services, the 

outpatient prospective payment system (OPPS) is more like a fee schedule 

and pays a designated rate for each outpatient service provided to a 

beneficiary. 

By law, the initial 2000 OPPS rates were based on hospitals’ 1996 median 

costs.1 During the development of OPPS, the anticipated use of 1996 data 

prompted concerns that the costs of new technology items, such as drugs, 

biologicals,2

 and devices, first used after 1996 would not be represented in 

the 2000 payment rates and that hospitals might not provide the newest 

technology because of a perceived shortfall in payment. Accordingly, 

Congressional concerns were raised that beneficiaries might lose access to 

some of these items upon implementation of the payment system.

The Centers for Medicare & Medicaid Services (CMS),3 the agency that 

administers Medicare, sets OPPS payment rates by using charges hospitals 

report to CMS for the outpatient services they provide. The agency has 

used this methodology since setting the 2000 rates. CMS converts each 

hospital’s charge to that hospital’s cost for each service using a specific 

1

 The Balanced Budget Act of 1997, Pub. L. No. 105-33, § 4523, 111 Stat. 251, 445 (1997).

2

 In this report, we use the term “drugs” to refer to both drugs and biologicals.

3

 In July 2001, the agency’s name was changed from the Health Care Financing 

Administration to CMS.
Page 2 GAO-04-772 Medicare Hospital Outpatient Payments

adjustment for each of the hospital’s departments. Under OPPS, an 

outpatient service consists of a primary service and its packaged services, 

the additional services or items associated with the primary service. For 

example, the surgical insertion of a pacemaker, a primary service, includes 

packaged services such as operating and recovery room services, 

anesthesia, and surgical and medical supplies, including the pacemaker. 

CMS combines the costs of the primary service and packaged services to 

calculate a total cost for that primary service. It assigns primary services to 

ambulatory payment classification (APC) groups and calculates a payment 

rate from the costs of the services in that group. An APC may consist of 

one primary service, but more often consists of two or more primary 

services with clinical and cost similarity. All primary services assigned to 

one APC are paid the same rate. 

In response to concerns that the 1996 data that would be used to set the 

2000 OPPS payment rates did not include cost data for new drugs and 

devices first used after 1996, in 1999, the Congress required that a payment 

be made for a temporary period, in addition to the OPPS amount, for 

certain drugs and devices used in the delivery of outpatient services.4

 New 

drugs and devices are eligible to receive these temporary additional 

payments, known as pass-through payments, for 2 to 3 years depending on 

when their eligibility first began and when cost data become available to 

incorporate these items into OPPS as either a primary or packaged service. 

These temporary payments for pass-through drugs generally are equal to 95 

percent of the average wholesale price (AWP),5

 and the temporary 

payments for pass-through devices are equal to CMS’s calculation of the 

hospital’s cost for the device.

In 2003, the first year for which pass-through eligibility expired for any 

drugs or devices, 236 drugs and 95 categories of devices6

 were incorporated 

4

 The Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 1999, Pub. L. No. 

106-113, App. F, § 201(b), 113 Stat. 1501A-321, 1501A-337 (1999).

5

 Often described as a “sticker price” or “list price,” AWP is the average price that a 

manufacturer suggests wholesalers charge pharmacies.

6

 Devices were initially eligible for pass-through payments based on the individual device. 

Effective April 1, 2001, devices are eligible for pass-through payments based on device 

categories, with an individual device eligible if it meets a category description. 
Page 3 GAO-04-772 Medicare Hospital Outpatient Payments

into OPPS.7 Of these drugs and devices, CMS designated 115 of the drugs 

primary services and the remaining 121 drugs and all devices packaged 

services. While those drugs that became primary services have assigned 

payment rates, the packaged drugs and devices do not. At the time CMS 

made the designations, some drug and device and hospital industry 

representatives noted that in basing the payment for these items on 

hospitals’ costs, Medicare payments for many had declined significantly. 

The drug and device industry representatives were concerned that if 

hospitals could not recover their costs through OPPS payments, hospitals 

would not purchase these items—in essence, limiting beneficiary access to 

the products. Some hospital association representatives were concerned 

that certain types of hospitals may provide a higher number of services 

associated with drugs and devices, such as cancer center hospitals 

providing chemotherapy services or teaching hospitals performing cardiac 

procedures involving devices, and therefore may be disproportionately 

affected by payment rate decreases for these items. Furthermore, the 

decrease in payment rates for drugs and devices led to broader concerns 

about how CMS ensures that OPPS payment rates for all services reflect 

hospitals’ costs. 

You asked us to examine these issues. Specifically, we (1) describe how 

payment rates changed for those drugs and devices whose pass-through 

eligibility expired in 2003 and 2004, (2) determine whether a particular type 

or types of hospitals provide a disproportionate number of Medicare 

outpatient services associated with drugs and devices, and (3) examine 

whether the OPPS rate-setting methodology results in payment rates that 

uniformly reflect hospitals’ costs for providing drugs and devices, as well 

as all other outpatient services, to beneficiaries, and if it does not, to 

identify specific factors of the methodology that are problematic.

7

 Since this group included all drugs and devices eligible over a 4-year period (from 

January 1, 1997 through January 1, 2001), many more items expired in 2003 than are 

expected to expire in any subsequent year. 
Page 4 GAO-04-772 Medicare Hospital Outpatient Payments

To address these objectives, we analyzed 2003 and 20048 OPPS payment 

rates and the 2003 and 2004 AWPs for former pass-through drugs that are 

primary services, which we refer to as separately paid drugs. The 

remaining drugs and all devices were packaged. Therefore, no identifiable 

2003 or 2004 payment rate for these items exists and we could not analyze 

any payment rate change. We also analyzed the Medicare hospital claims, 

the bills hospitals submit to CMS for payment, that were used to set the 

2003 OPPS rates.9

 These claims were the latest data available at the time of 

our analysis, and we determined they were reliable for our purposes. From 

the claims data, we identified the outpatient services most often associated 

with drugs or devices.10 We determined whether any hospital type provided 

a disproportionate number of these outpatient services, such as hospitals 

with and without an outpatient cancer center or major teaching status, with 

major teaching hospitals defined as those having an intern/resident-to-bed 

ratio of 0.25 or more. We also analyzed hospitals by their urban/rural 

location and by their volume of outpatient services. We analyzed 

information from 113 hospitals on how they set their charges for drugs, 

devices, and other outpatient services. Of these hospitals, we interviewed 

officials from 5, received information from another 50 through association 

and industry representatives who gathered the information on our behalf, 

and received information from another 58 who were contacted by 7 state 

hospital associations in geographically diverse areas on our behalf. 

Because these 113 hospitals are not statistically representative of all 

hospitals, we cannot generalize our results to other hospitals. Finally, we 

spoke with officials at CMS, individual hospitals, hospital associations, 

drug and device manufacturers, and trade associations representing 

manufacturers of drugs and devices. We also spoke with consultants who 

advise hospitals on setting charges for their services. Our methodology is 

detailed in appendix I. We conducted our work from March 2003 through 

8

 In our analysis, we used the 2004 OPPS payment rates set by CMS in the November 7, 2003 

final rule, which were based on hospital costs and hospital outpatient claims. 68 Fed. Reg. 

63,398 (2003). These rates do not reflect provisions that limited the amount of fluctuation 

between the 2003 and 2004 rates that were implemented on January 1, 2004 as a result of the 

Medicare Prescription Drug, Improvement, and Modernization Act of 2003. We did not 

analyze the updated rates because they were not based on hospital costs or hospital 

outpatient claims. Pub. L. No. 108-173, § 621, 117 Stat. 2066, 2307 (2003).

9

 These claims are for services performed from April 1, 2001 through March 31, 2002.

10 We analyzed all outpatient drugs that were individually identified in the outpatient claims 

data, not only the drugs classified as pass through. We could analyze only pass-through 

devices because these devices were individually identified in the outpatient claims, while 

other devices were not.
Page 5 GAO-04-772 Medicare Hospital Outpatient Payments

August 2004 in accordance with generally accepted government auditing 

standards.

Results in Brief The OPPS payment rates of former pass-through, separately paid, drugs 

were generally lower than the pass-through payment rate, but the payment 

rates of former pass-through drugs and devices that were packaged cannot 

be evaluated, as these items are not assigned a distinct payment rate. The 

payment rates for the 115 of 236 former pass-through drugs that expired 

from pass-through eligibility in 2003 and became separately paid drugs 

almost universally decreased from the pass-through payment rate of 95 

percent of AWP. Because the remaining 121 pass-through drugs and the 

devices in the 95 pass-through device categories were packaged and are not 

assigned to an APC, we cannot evaluate any payment rate changes for 

these items. In 2003, over 90 percent, and in 2004, 100 percent, of former 

pass-through drugs that CMS designated as separately paid drugs had 

payment rates lower than 95 percent of AWP. In both years, the payment 

rates were often considerably lower than AWP, but decreases varied 

substantially. For example, although the 2003 median drug payment rate 

was 55 percent of AWP, one drug had a 2003 payment rate about 7 percent 

of AWP, while another had a 2003 payment rate about 94 percent of AWP. 

No type of hospital provided a disproportionate number of Medicare 

outpatient services associated with certain drugs and devices; in 2001, 

these outpatient services as a percentage of total Medicare outpatient 

services varied little among different hospital types. For example, 

chemotherapy administrations—the outpatient services most frequently 

associated with the use of drugs—accounted for an average of 1.8 percent 

of all hospitals’ total number of Medicare outpatient services. 

Chemotherapy administration services accounted for an average of 2.0 

percent of cancer center hospitals’ and 1.8 percent of noncancer center 

hospitals’ total Medicare outpatient services. Cardiac procedures—the 

outpatient services most frequently associated with the use of devices—

accounted for an average of 0.4 percent of all hospitals’ total number of 

Medicare outpatient services. Similarly, these cardiac procedures 

accounted for an average of 0.4 percent of both major teaching and all 

other hospitals’ total Medicare outpatient services.

The OPPS rate-setting methodology used by CMS may result in APC 

payment rates for drugs, devices, and other outpatient services that do not 

uniformly reflect hospitals’ costs of providing those services. Two areas of 

the methodology are particularly problematic. First, the claims that CMS 
Page 6 GAO-04-772 Medicare Hospital Outpatient Payments

uses to calculate hospitals’ costs and set payment rates may not be a 

representative sample of hospital claims, as CMS has excluded over 40 

percent of multiple-service claims, claims that include more than one 

primary service as well as packaged services, when calculating the cost of 

all OPPS services, including those with drugs and devices. It excludes 

these multiple-service claims because outpatient claims list all the services 

delivered during a visit and do not provide a link between primary and 

packaged services. Because CMS cannot associate each packaged service 

on the claim with one of the primary services listed on the claim, the 

agency cannot calculate a total cost for each primary service on that claim. 

The data CMS has available do not allow for the determination of whether 

excluding a sizable percentage of the multiple-service claims has an effect 

on OPPS payment rates. However, if the types or costs of services on 

excluded claims differ from the types or costs of services on included 

claims, the payment rates of some or all APCs will not uniformly reflect 

hospitals’ costs of providing those services. Second, in calculating 

hospitals’ costs, CMS assumes that, in setting charges within a specific 

department, a hospital marks up the cost of each service by the same 

percentage. However, many hospitals do not use this methodology; chargesetting methodologies for drugs, devices, and other outpatient services 

vary greatly both across hospitals and departments of a hospital. CMS’s 

methodology does not recognize hospitals’ variability in setting charges. 

This may lead to an under or overestimation of hospitals’ costs for certain 

services. As these costs are used to set payment rates, payment rates may 

not uniformly reflect hospitals’ costs. 

We recommend that the Administrator of CMS gather the necessary data 

and perform an analysis of the types and costs of services on excluded 

multiple-service claims to determine if they are different from the types and 

costs of services on the claims it includes in setting OPPS rates. The 

Administrator should also analyze the effect that the variation in hospital 

charge-setting practices has on the rate-setting methodology. Finally, the 

Administrator should, in the context of the first two recommendations, 

analyze whether the OPPS rate-setting methodology results in payment 

rates that uniformly reflect hospitals’ costs of the outpatient services they 

provide to Medicare beneficiaries, and, if it does not, make appropriate 

changes in that methodology. In commenting on a draft of this report, CMS 

stated that it has continued to review and refine its OPPS data collection 

and analysis. CMS stated that it is searching for ways to use more data 

from multiple-service claims, and it has made efforts in recent rate-setting 

analyses to include data from more of these claims. We included a 

discussion of these changes in the draft report. In its comments, CMS 
Page 7 GAO-04-772 Medicare Hospital Outpatient Payments

stated that we should recognize that its rate-setting methodology that 

converts hospital charges to costs using a cost-to-charge ratio does so at 

the level of an individual hospital department. The draft report noted the 

fact that cost-to-charge ratios were generally calculated on a departmentspecific basis; however, we have revised the report to highlight that 

information throughout. CMS stated that it will consider our 

recommendations as it continues to assess and refine the rate-setting 

methodology. Industry representatives who reviewed a copy of this draft 

generally agreed with the findings, conclusions, and recommendations.

Background Medicare beneficiaries receive a wide range of services in hospital 

outpatient departments, such as emergency room and clinic visits, 

diagnostic services such as x-rays, and surgical procedures. To receive 

Medicare payment, hospitals report the services they provided to a 

beneficiary on a claim form they submit to CMS along with their charge for 

each service. For Medicare payment purposes, an outpatient service 

consists of a primary service and packaged services, the additional services 

or items associated with that primary service. CMS assigns each primary 

service to an APC, which may include other similar primary services, and 

pays the hospital at the designated APC payment rate, adjusted for 

variation in local wages. A hospital can receive multiple APC payments for 

a single outpatient visit if more than one primary service is delivered during 

that visit.

CMS Methodology for 

Determining APC Payment 

Rates 

On outpatient claims, hospitals identify the primary services they provided 

using a Healthcare Common Procedure Coding System (HCPCS)11 code, 

while they identify packaged services by either specific HCPCS codes or 

revenue codes that represent general hospital departments or centers, such 

as “pharmacy,” “observation room,” or “medical social services.” In 

addition to claims, hospitals submit annual cost reports to CMS that state 

their total charges and costs for the year and the individual hospital 

department charges and costs.

As a first step in calculating the OPPS payment rate for each APC, CMS 

obtains hospital charge data on each outpatient service from the latest 

11 The HCPCS is a uniform system of codes used by providers and medical suppliers to 

report professional services, procedures, and supplies.
Page 8 GAO-04-772 Medicare Hospital Outpatient Payments

available year of outpatient claims. It calculates each hospital’s cost for 

each service by multiplying the charge by a cost-to-charge ratio that is 

computed from the hospital’s most recent cost report, generally on an 

outpatient department-specific basis. In those instances when a cost-tocharge ratio does not exist for an outpatient department in a given hospital, 

CMS uses one from a related outpatient department or the hospital's 

overall cost-to-charge ratio for outpatient department services. The cost of 

each primary service is then combined with the costs of the related 

packaged services to calculate a total cost for that primary service. On 

single-service claims, claims with one primary service, CMS can associate 

packaged services with the primary service and calculate a total cost for 

the service (see fig. 1). However, in the case of multiple-service claims, 

claims with more than one primary service, packaged services and their 

costs listed on the claim cannot be associated with particular primary 

services, as the costs of a packaged service may be associated with one or a 

combination of primary services (see fig. 2). For this reason, CMS 

excluded all multiple-service claims from rate setting prior to 2003. 

Beginning with the 2003 payment rates, CMS identified several methods 

that allowed it to convert some multiple-service claims into single-service 

claims, and therefore include them in its rate-setting calculations.12

12 For multiple-service claims that have no packaged services, CMS considers each primary 

service its own single-service claim. Similarly, CMS treats each pathology service on a 

multiple-service claim as its own single-service claim. If a multiple-service claim contains 

one primary service together with certain other primary services that CMS states do not 

typically have packaged services associated with them, such as a chest X-ray or an 

electrocardiogram, CMS assigns all packaged services to that one primary service and treats 

it as a single-service claim. In addition, if the claim includes the date for each service and 

each primary service has a different date, CMS uses the dates of service associated with 

packaged services listed on the claims to match them to primary services with the same 

dates of service, and makes each primary service its own single-service claim. 
Page 9 GAO-04-772 Medicare Hospital Outpatient Payments

Figure 1: Example of a Single-Service Claim with Packaged Services

Figure 2: Example of a Multiple-Service Claim with Packaged Services

After calculating the cost of each primary service assigned to an APC for 

each hospital claim, CMS arrays the costs for all claims and determines the 

median cost. To calculate the APC’s weight relative to other APCs, CMS 

compares the median cost of each APC to the median cost of APC 0601, a 

mid-level clinic visit, which is assigned a relative weight of 1.00. For 

example, if the median cost of APC 0601 is $100 and the median cost of 

“APC A” is $50, CMS assigns APC A a relative weight of 0.50.

To obtain a payment rate for each APC, CMS multiplies the relative weight 

by a factor that converts it to a dollar amount. In addition, CMS annually 

reviews and revises the services assigned to a particular APC and uses the 

Single-Service Claim: This claim has one primary service (emergency department 

visit). All of the packaged services (pharmacy, supplies) are associated with that primary 

service. This claim would be included by CMS in setting APC payment rates.

TOTAL CHARGES

120.00 

30.00 

DESCRIPTION

Pharmacy

Supplies

SERVICE DATE

10/2/02

10/2/02

HCPCS

Emerg yp enc department visit 99284 10/2/02 400.00 

Source: GAO.

Multiple-Service Claim: This claim has more than one primary service (emergency 

department visit and treat humerus fracture) performed on the same date. The 

packaged services (pharmacy, supplies) may be associated with either or both primary 

services. This claim would be excluded by CMS in setting the APC payment rates.

 TOTAL CHARGES

120.00 

30.00 

DESCRIPTION

Pharmacy

Supplies

SERVICE DATE

10/2/02

10/2/02

HCPCS

Treat humerus fracture 24538 10/2/02 2000.00 

Emergency department visit 99284 10/2/02 400.00 

Source: GAO.
Page 10 GAO-04-772 Medicare Hospital Outpatient Payments

new APC assignments and the charges from the latest available outpatient 

hospital claims to recalibrate the relative weights, and therefore the 

payment rates.

Expiration of Drug and 

Device Pass-Through 

Eligibility

New drugs and devices are eligible to receive temporary pass-through 

payments for 2 to 3 years, depending on when each drug and device’s 

eligibility began. January 1, 2003 was the first time that pass-through 

eligibility expired for any drugs or devices. Once pass-through eligibility 

for these items expires, CMS determines whether they will be considered a 

primary service and assigned to a separate APC or a packaged service and 

included with the primary services with which they are associated on a 

claim. 

On January 1, 2003, 236 drugs and on January 1, 2004, 7 drugs expired from 

pass-through eligibility. For those drugs expiring in 2003, CMS designated 

any drug with a median cost exceeding $150 (115 drugs) as a primary 

service, and each was assigned to its own, separately paid APC. The 

remaining drugs (121 drugs), those with a median cost less than $150, were 

designated as packaged services, that is, their costs were included with the 

costs of the primary service they were associated with on the claim. CMS 

stated that many of these latter drugs were likely present on claims with a 

primary service of drug administration and were therefore packaged with 

the services assigned to the six drug administration APCs, that is, the three 

chemotherapy administration and three drug injection and infusion APCs.13 

For these packaged drugs, although hospitals had previously received two 

payments, one for the administration of the drug or other primary service 

and an additional pass-through payment for the drug itself, when eligibility 

expires, hospitals receive only one payment for both the administration or 

other primary service and the packaged drug. In 2004, all 7 drugs for which 

pass-through eligibility expired were designated as primary services and 

assigned to their own, separately paid APCs.

On January 1, 2003, the devices in 95 device categories, and on January 1, 

2004, the devices in 2 device categories, expired from pass-through 

eligibility; in both years, the devices in all device categories were 

13 CMS expects that most drug charges would be present on claims that also include the 

service for the administration of the drug; however, it is possible that drug charges are 

present on claims with primary services other than an administration and are included in the 

APCs to which those primary services are assigned. 
Page 11 GAO-04-772 Medicare Hospital Outpatient Payments

designated as packaged services and their costs were included with the 

costs of the primary service they were associated with on the claim. 

Although hospitals had previously received two payments, one for the 

procedure associated with the device and an additional pass-through 

payment for the device, hospitals then received only one payment for both 

the procedure and its associated device. 

Payment Rates Were 

Generally Lower for 

Separately Paid Drugs, 

but Cannot Be 

Evaluated for 

Packaged Drugs and 

Devices

The OPPS payment rates of former pass-through, separately paid drugs 

were generally lower than the pass-through payment rate, but the payment 

rates of former pass-through drugs and devices that were packaged cannot 

be evaluated, as these items are not assigned a distinct payment rate. In 

2003, the payment rates for the 115 of 236 former pass-through drugs that 

were designated as separately paid drugs almost universally decreased 

from the pass-through payment rates. In 2004, for all 7 former pass-through 

drugs were designated as separately paid drugs and the payment rates for 

all 7 decreased. In 2003, for the remaining 121 pass-through drugs and the 

devices in 95 pass-through device categories and, in 2004, the devices in 2 

device categories, all of which were packaged, we cannot evaluate the 

payment rate changes because individual payment rates were not assigned 

for these items when they expired from pass-through eligibility. 

Payment Rates Generally 

Decreased For Separately 

Paid, Former Pass-Through 

Drugs

In 2003, about half of all drugs for which pass-through eligibility expired 

(115 of 236) were assigned to their own APC and paid separately. For these 

drugs, we determined that over 90 percent had payment rates lower than 95 

percent of AWP, the pass-through payment rate; the median payment rate 

was 55 percent of AWP.14 Individual payment rates were often considerably 

lower than AWP, but decreases varied substantially. For example, 1 drug 

had a payment rate of about 7 percent of AWP, while another had a payment 

rate of about 94 percent of AWP. However, 10 drugs had a payment rate of 

more than 100 percent of AWP. In addition, payment as a percentage of 

AWP varied by drug source. The majority of the 113 separately paid drugs 

that we analyzed were sole-source (70 percent), followed by multi-source 

14 This analysis excludes 2 drugs: 1 for which we were unable to determine a reliable AWP, 

and 1 for which the payment rate was an extremely high percentage of AWP. 
Page 12 GAO-04-772 Medicare Hospital Outpatient Payments

(19 percent), and generic (10 percent).15 Generic drugs, which were paid 

the highest percentage of AWP of the three categories, had a median 

payment rate of 74 percent of AWP, multi-source drugs had a median of 56 

percent of AWP, and sole-source drugs had a median of 53 percent of AWP. 

In 2004, all seven drugs for which pass-through eligibility expired were 

assigned to separate APCs. The individual payment rate of each drug was 

lower than the pass-through rate of 95 percent of AWP, with a median 

payment rate of 69 percent of AWP. All drugs were sole-source.

Although the decreases in payments for these drugs were often substantial 

and varied greatly across individual drugs, some level of decrease is 

expected when pass-through eligibility expires and payments become 

based on hospital costs instead of AWP, which often exceeds providers’ 

acquisition costs. In 2001, we reported that certain drugs purchased by 

individual physicians were widely available at costs from 66 to 87 percent 

of AWP.16 

Packaged Drugs and 

Devices Do Not Have 

Distinct Payment Rates 

In 2003, the costs of 121 former pass-through drugs and devices in 95 

former pass-through device categories were packaged. Because CMS 

combines the costs of these items with the costs of the primary services 

with which they are associated on each claim, a specific payment rate for 

each of these drugs and devices does not exist. However, to indirectly 

assess the payment rates of packaged drugs and devices, we reviewed the 

payment rates of the APCs with which CMS stated they were likely 

packaged. CMS stated that, in 2003, former pass-through drug costs were 

most likely packaged with the six drug administration APCs. The payment 

rates for five of the six APCs decreased in 2003, when the costs of 

packaged former pass-through drugs were included, compared to 2002, 

when the costs of these drugs were not considered in the rate-setting 

calculations (see table 1). We are unable to determine why the costs of 

these APCs decreased because fluctuations in costs for any of the primary 

or packaged services in these APCs, in addition to the costs of the 

15 Generally, “sole-source” drugs are brand-name drugs produced by only one manufacturer, 

“multi-source” drugs are drugs with generic equivalents or drugs for which there are two or 

more competing therapeutically-equivalent brand-name products, and “generic” drugs are 

not patented and can be produced by many manufacturers.

16 GAO, Medicare: Payments for Covered Outpatient Drugs Exceed Providers’ Cost, 

GAO-01-1118 (Washington, D.C.: Sept. 21, 2001).
Page 13 GAO-04-772 Medicare Hospital Outpatient Payments

packaged drug, could have affected the payment rates. However, we would 

have expected that combining the costs of up to $150 of packaged former 

pass-through drugs with the costs of the primary services in these APCs 

would have increased the 2003 payment rates for more of these APCs as 

more than half of them are less than $150. 

Table 1: Payment Rates for Drug Administration APCs, 2002-2003

Source: GAO analysis of APC payment rates (67 Fed. Reg. 9,556, 9,569, 9,572 (2002); 67 Fed. Reg. 66,815, 66,818 (2002)).

To indirectly assess the payment rates of the devices in the 95 device 

categories expiring from pass-through eligibility in 2003, we reviewed APCs 

for which CMS determined that device costs made up at least 1 percent of 

the APC’s total cost.17 We found that the payment rates of these APCs 

varied substantially between 2002 and 2003, when the former pass-through 

device costs likely were included. For example, the payment rate of APC 

0688 (Revision/Removal of Neurostimulator Pulse Generator Receiver) 

decreased by 48 percent, while the payment rate of APC 0226 (Implantation 

of Drug Infusion Reservoir) increased by 94 percent. However, we cannot 

attribute these fluctuations solely to the packaging of pass-through devices, 

because changes between 2002 and 2003 in the costs of the primary 

services and other packaged services assigned to the APCs also could have 

affected the payment rates. 

In 2004, the devices in two device categories expired from pass-through 

eligibility. The devices in one category were associated with services in 

APC Description 2002 2003 Difference

Percent 

change

0116 Chemotherapy administration by 

other technique except infusion $46.32 $40.43 -$5.89 -13%

0117 Chemotherapy administration by 

infusion only 205.14 187.98 -17.16 -8

0118 Chemotherapy administration by 

both infusion and other technique 214.81 286.02 71.21 33

0120 Infusion therapy except 

chemotherapy 157.80 113.70 -44.10 -28

0352 Level I injections 20.87 11.62 -9.25 -44

0359 Level II injections 91.63 59.12 -32.51 -35

17 These APCs are identified in 67 Fed. Reg. 66,801-2 (2002).
Page 14 GAO-04-772 Medicare Hospital Outpatient Payments

one APC—APC 0674 (Prostate Cryoablation). The payment rate for this 

APC almost doubled. We were unable to examine the change in payment 

for the APC or APCs associated with the devices in the other expired passthrough device category because CMS did not identify the APC or APCs 

into which the costs of the devices in this device category were packaged. 

No Type of Hospital 

Provided a 

Disproportionate 

Number of Services 

Associated with 

Certain Drugs and 

Devices

No type of hospital provided a disproportionate number of Medicare 

outpatient services associated with certain drugs and devices, as these 

services, as a percentage of total Medicare outpatient services, varied little 

among hospitals with differences in characteristics such as the presence of 

an outpatient cancer center, teaching status, urban or rural location, or 

outpatient service volume.18 

In 2001, outpatient drugs were most often associated with APCs for 

chemotherapy administration services, and devices in pass-through device 

categories were most often associated with APCs for cardiac services.19 

We found that chemotherapy administration and cardiac services 

composed only a small proportion of total Medicare outpatient services for 

all hospitals (see table 2). In addition, these proportions varied little among 

different types of hospitals. 

18 We defined “cancer center hospitals” as those hospitals that were members of the 

Association of Community Cancer Centers as of February 28, 2003, the latest data available 

when we performed this analysis. We defined teaching status by a hospital’s intern/residentto-bed ratio. We defined a major teaching hospital as a hospital with an intern/resident-tobed ratio of 0.25 or more and a hospital without major teaching hospital status having a ratio 

of less than 0.25.

19 We analyzed all outpatient drugs identified by a HCPCS code in the outpatient claims data, 

not only the drugs that had pass-through eligibility. We could analyze only pass-through 

devices because these devices were specifically identified in the outpatient claims while 

other devices were not.
Page 15 GAO-04-772 Medicare Hospital Outpatient Payments

Table 2: Percentage of Medicare Outpatient Services by Type for All Hospitals and 

for Hospitals with Various Characteristics

Source: GAO analysis of CMS data. 

Notes: We used hospital outpatient claims from April 1, 2001 through March 31, 2002, the claims CMS 

used to set the 2003 OPPS rates, applied to hospital categories defined in 2003. We defined “cancer 

center hospitals” as those hospitals that were members of the Association of Community Cancer 

Centers as of February 28, 2003, the latest data available when we performed this analysis. We 

defined a major teaching hospital as a hospital with an intern/resident-to-bed ratio of 0.25 or more and 

a hospital without major teaching hospital status as a ratio of less than 0.25. We defined the urban or 

rural location of a hospital using Medicare’s classification of that hospital under OPPS. We defined 

volume based on the number of outpatient services a hospital provided. Small volume hospitals were 

those with fewer than 11,000 services, medium volume hospitals were those with at least 11,000 

services but fewer than 43,000 services, and large volume hospitals were those with at least 43,000 

services. 

Payment Rates May 

Not Uniformly Reflect 

Hospitals’ Costs

The OPPS rate-setting methodology used by CMS may result in APC 

payment rates for drugs, devices, and other outpatient services that do not 

uniformly reflect hospitals’ costs. Two areas of CMS’s methodology are 

particularly problematic. First, the claims that CMS uses to calculate 

hospitals’ costs and set payment rates may not be a representative sample 

of hospital claims, as CMS excluded many multiple-service claims when 

calculating the cost of OPPS services, including those with drugs and 

devices. The data CMS has available do not allow for the determination of 

whether excluding many multiple-service claims has an effect on OPPS 

payment rates. However, if the types or costs of services on excluded 

Number of 

hospitals

Chemotherapy 

administration 

services as a percent 

of total Medicare 

outpatient services

Cardiac services 

as a percent of 

total Medicare 

outpatient services

All hospitals 4,034 1.8 0.4

Cancer center hospitals 555 2.0 0.5

Noncancer center 

hospitals 3,479 1.8 0.3

Major teaching hospitals 288 2.4 0.4

Hospitals without major 

teaching hospital status 3,746 1.7 0.4

Urban hospitals 2,493 1.7 0.5

Rural hospitals 1,541 2.3 0.2

Small volume hospitals 1,258 1.0 0.1

Medium volume hospitals 1,840 1.3 0.3

Large volume hospitals 936 2.2 0.5
Page 16 GAO-04-772 Medicare Hospital Outpatient Payments

claims differ from the types or costs of services on included claims, the 

payment rates of some or all APCs may not uniformly reflect hospitals’ 

costs of providing those services. Second, when calculating hospitals’ 

costs, CMS assumes that, in setting charges within a specific department, a 

hospital marks up the cost of each service by the same percentage. 

However, not all hospitals use this methodology, and charge-setting 

methodologies for drugs, devices, and other outpatient services vary 

greatly across hospitals and across departments within a hospital. CMS’s 

methodology does not recognize hospitals’ variability in setting charges, 

and, therefore, the costs of services used to set payment rates may be 

under or overestimated.

CMS May Not Be Using a 

Representative Sample of 

Claims to Set Payment 

Rates

The claims CMS uses to calculate hospitals’ costs and set payment rates 

may not be a representative sample of hospital claims. When calculating 

the cost of all OPPS services, including drugs and devices, to set payment 

rates, CMS excluded over 40 percent of all multiple-service claims because 

CMS could not associate particular packaged services with a specific 

primary service on these claims.20 Drug and device industry 

representatives we spoke with raised concerns that certain drugs and 

devices are often billed on multiple-service claims that are largely excluded 

from rate setting. For example, they stated that chemotherapy 

administration and the drugs themselves are typically billed on a 30-day 

cycle; therefore, one claim likely includes chemotherapy administration 

and other primary and packaged services and is likely excluded from CMS’s 

rate-setting calculations.21 Device industry representatives we spoke with 

also asserted that multiple-service claims represent more complex, and 

therefore, potentially costlier, outpatient visits and excluding them from 

the rate-setting calculations underestimates the actual cost of a service. 

Because of the structure of the outpatient claim, the data CMS has 

20 In 2003 and 2004, CMS used 53 percent of the approximately 20.4 million and 58 percent of 

the approximately 16.9 million multiple-service claims to set its rates, respectively. In the 

same years, the exclusion of the multiple-service claims from the analysis resulted in CMS 

using only 81 and 83 percent of all claims, respectively.

21 Beginning in 2004, CMS uses the dates of service associated with packaged services listed 

on a claim to match them to primary services with the same dates of service to create a 

single service claim. Thus, claims with only chemotherapy administration and packaged 

services including drugs, and no other primary services delivered on the same dates, would 

be included in rate setting, however claims with chemotherapy administration, packaged 

services, and additional primary services delivered on the same date or dates would be 

excluded.
Page 17 GAO-04-772 Medicare Hospital Outpatient Payments

available do not allow for the comparison of single-service claims and 

multiple-service claims to determine whether excluding many multipleservice claims has an effect on OPPS payment rates. It is possible that 

excluding many multiple-service claims has little or no effect on OPPS 

payment rates. However, if the types or costs of services on excluded 

claims differ from the types or costs of services on included claims, the 

payment rates of some or all APCs may not uniformly reflect hospitals’ 

costs of performing these services. 

Rate-Setting Methodology 

Does Not Account for 

Variation in Hospital 

Charge-Setting Practices

The costs of drugs, devices, and other outpatient services that CMS 

calculates from hospital charges and uses to set payment rates may not 

uniformly approximate hospitals’ costs. CMS multiplies charges by 

hospital-specific cost-to-charge ratios to calculate hospitals’ costs, which 

decreases the charges by a constant percentage. This methodology is 

based on the assumption that each hospital marks up its costs by a uniform 

percentage within each department to set each service’s charge. However, 

we found that not all hospitals use this methodology to establish their 

charges, and that drug, device, and general charge-setting methodologies 

vary greatly among hospitals and even among departments within the same 

hospitals. 

We received information from 113 hospitals, although not all hospitals 

responded to each question. Of the 92 hospitals responding, 40 reported 

that they mark up all drug costs by a uniform percentage to establish 

charges, but 33 reported that they mark up low-cost drugs by a higher 

percentage and high-cost drugs by a lower percentage. Of 85 hospitals 

responding, 39 reported that they mark up all device costs using a uniform 

percentage, but 39 reported that they mark up low-cost devices using a 

higher percentage and high-cost devices using a lower percentage. In 

addition, 19 hospitals reported using other methods to set drug charges and 

7 reported doing so for devices, such as a lower percentage markup for 

low-cost drugs and devices than for high-cost drugs and devices. (See 

appendix II for a more detailed description of hospital charge-setting 

methodologies.)

Because CMS uses the same rate-setting methodology to determine drug 

and device payment rates as it uses for all other OPPS services, we also 

asked hospitals about more general charge-setting practices and found that 

they varied as well. To set base charges for clinic visits, hospitals reported 

using a wide variety of prices and methods, including cost, market 

comparisons, and the rates Medicare pays for outpatient services as well as 
Page 18 GAO-04-772 Medicare Hospital Outpatient Payments

payment rates for other benefit categories. To mark up clinic visits, 29 of 

the 45 hospitals responding used a uniform percentage increase; the 

remaining 16 hospitals reported using a variety of other methods, including 

using a higher percentage markup for low-cost visits than for high-cost 

visits. 

In addition to variation in charge-setting methodologies among hospitals, 

variation also can exist within an individual hospital. Hospital consultants 

told us that a single item can be assigned different charges if it is provided 

through more than one department within the same hospital.

All 58 hospitals responding reported that they update their charges for 

inflation; 40 reported they did so annually, 12 did so at other times, and 6 

did so both annually and at other times. Of the 58 hospitals that reported 

updating their charges for inflation, 25 reported that they apply a uniform, 

across-the-board percentage increase to all their charges, and 4 hospitals 

reported using both a uniform percentage and another type of increase. 

The remaining 29 hospitals reported using another method, such as 

applying an increase only to selected departments within the hospital. In 

addition, 33 of the 57 hospitals reported that they excluded some charges 

from these updates. The type of charges they excluded varied widely, but 

included drug and laboratory charges. The variation in methods hospitals 

use to update their charges reduces the likelihood that charges will 

uniformly reflect costs. 

Conclusions CMS’s rate-setting methodology may result in OPPS payment rates that do 

not uniformly reflect hospitals’ costs of providing services. We identified 

two areas of this methodology that are of particular concern because not 

enough data are currently available to assess their impact. First, CMS 

excludes many multiple-service claims from its rate-setting calculations. 

To the extent that the types and costs of services on these claims are 

different from services on the claims included in the analysis, OPPS 

payment rates may not reflect hospitals’ costs. The current structure of the 

outpatient claims does not allow for an analysis to determine the effect of 

these exclusions. Second, in its rate-setting calculations, CMS assumes 

that each hospital uses a uniform markup percentage to set its charges 

within each department, although we found that hospitals use a variety of 

markup methodologies. Therefore, CMS’s application of a constant cost-tocharge ratio may not result in an accurate calculation. 
Page 19 GAO-04-772 Medicare Hospital Outpatient Payments

Recommendations for 

Executive Action

We recommend that the Administrator of CMS take the following three 

actions. First, the Administrator should gather the necessary data and 

perform an analysis that compares the types and costs of services on 

single-service claims to those on multiple-service claims. Second, the 

Administrator should analyze the effect that the variation in hospital 

charge-setting practices has on the OPPS rate-setting methodology. Third, 

the Administrator should, in the context of the first two recommendations, 

analyze whether the OPPS rate-setting methodology results in payment 

rates that uniformly reflect hospitals’ costs of the outpatient services they 

provide to Medicare beneficiaries, and, if it does not, make appropriate 

changes in that methodology. 

Agency and External 

Reviewer Comments 

and Our Evaluation

We received written comments on a draft of this report from CMS (see app. 

III). We also received oral comments from external reviewers representing 

seven industry organizations. They included the Advanced Medical 

Technology Association (AdvaMed), which represents manufacturers of 

medical devices, diagnostic products, and medical information systems; 

the American Hospital Association (AHA); the Association of American 

Medical Colleges (AAMC), which represents medical schools and teaching 

hospitals; the Association of Community Cancer Centers (ACCC); the 

Biotechnology Industry Organization (BIO), which represents 

biotechnology companies and academic institutions conducting 

biotechnology research; the Federation of American Hospitals (FAH), 

which represents for-profit hospitals; and the Pharmaceutical Research and 

Manufacturers of America (PhRMA).

CMS Comments and Our 

Evaluation

In commenting on a draft of this report, CMS stated that it has continued to 

review and refine its OPPS data collection and analysis. In responding to 

our recommendation that CMS gather the necessary data and perform an 

analysis comparing the types and costs of services on single-service claims 

to those on multiple-service claims, CMS stated that it is searching for ways 

to use more data from multiple-service claims, and it has made efforts in 

recent rate-setting analyses to include data from more of these claims. We 

noted these efforts in the draft report. CMS noted that there are continuing 

challenges and costs, to both the federal government and hospitals, to 

expanding its efforts in this area. In its comments, CMS suggested that an 

analysis could be done using an algorithm to allocate charges among 

multiple-service claims, but noted that such an approach could create 

further distortions in the relative weights. Our recommendation to CMS, 
Page 20 GAO-04-772 Medicare Hospital Outpatient Payments

however, is that the agency should gather additional data on the relative 

costs of services on single and multiple-service claims, rather than 

continuing to analyze existing data. 

In response to our recommendation that CMS analyze the effect of hospital 

charge-setting practices on the OPPS rate-setting methodology, CMS stated 

that we should recognize that its rate-setting methodology that converts 

hospital charges to costs using a cost-to-charge ratio does so at the level of 

an individual hospital department. The draft report noted the fact that CMS 

generally calculates cost-to-charge ratios on a department-specific basis; 

however, we have revised the report to highlight that information 

throughout. CMS also said that the application of cost-to-charge ratios to 

charges of a hospital has long been the recognized method of establishing 

reasonable costs for hospital services and was an important component of 

the cost-based reimbursement system that was used by Medicare to pay for 

hospital outpatient services before OPPS was implemented. While we 

agree that it was an important component of the prior payment system, we 

believe the implementation of the current payment system has changed the 

relevance of applying cost-to-charge ratios to determine hospitals’ costs. 

OPPS, rather than reimbursing individual hospitals on the basis of their 

costs of providing outpatient services, uses costs from individual hospitals 

to construct a prospective payment system that sets rates for individual 

services that apply to all hospitals. Finally, CMS stated that the Medicare 

Prescription Drug, Improvement, and Modernization Act of 2003 specified 

that cost-to-charge ratios would be used to set payment amounts for 

brachytherapy sources; however, a discussion of brachytherapy payment is 

outside of the scope of this report. 

In response to our recommendation that CMS analyze whether the OPPS 

rate-setting methodology results in payment rates that uniformly reflect 

hospitals’ costs of the services they provide to Medicare beneficiaries and 

make any appropriate changes in the methodology, CMS stated that it will 

consider our recommendations as it continues to assess and refine the ratesetting methodology. CMS said that it believes it has made great strides on 

this issue and is continuing to pursue the analyses necessary to create 

means by which all claims can be used to set the OPPS relative payment 

weights and rates. 

CMS also made technical comments, which we incorporated where 

appropriate. 
Page 21 GAO-04-772 Medicare Hospital Outpatient Payments

Industry Comments and Our 

Evaluation

Industry representatives generally agreed with the findings, conclusions, 

and recommendations in the draft report. Comments on specific portions 

of the draft report centered on three areas: payment rates of former passthrough drugs and devices, provision of services associated with drugs and 

devices, and CMS’s rate-setting methodology.

Several industry representatives commented on our analysis of Medicare 

payment for former pass-through drugs and devices. AHA stated that 

although when drugs have expired from pass-through status their payment 

rates may have decreased, they are now more consistent, relative to costs, 

with the payment rates for other OPPS services. PhRMA agreed with our 

finding that the payment rates for former pass-through drugs and devices 

that are packaged cannot be evaluated and suggested that we recommend 

that CMS specifically address this problem. 

Industry representatives commented on our analysis of the provision of 

services associated with drugs and devices among different types of 

hospitals. ACCC agreed with the percentages of Medicare outpatient 

services related to chemotherapy administration and cardiac services in 

the draft report; however, it stated that it believed that these percentages 

demonstrated that large hospitals provided a disproportionate share of 

chemotherapy administration. ACCC and AAMC stated that these 

percentages also demonstrated that major teaching hospitals provided a 

disproportionate share of chemotherapy administration services. In 

addition, both groups suggested that we perform other analyses by type of 

hospital, such as the proportion of total payments, proportion of total 

services excluding clinic services, or absolute number of services for which 

chemotherapy administration and cardiac services accounted.

Many of the reviewers addressed our finding that CMS’s rate-setting 

methodology may result in OPPS payment rates that do not uniformly 

reflect hospitals’ costs. Representatives from AAMC, ACCC, AdvaMed, 

BIO, and PhRMA agreed with our conclusion that CMS may not be using a 

representative sample of claims to set payment rates and that CMS’s ratesetting methodology does not account for variation in hospital chargesetting practices. Several of these representatives suggested we analyze 

and discuss other factors that could further skew CMS’s calculation of 

hospital costs, such as its use of incorrect or incomplete claims in rate 

setting. 

Regarding the suggestion that we specifically recommend that CMS 

address the issue that the payment rates for former pass-through drugs that 
Page 22 GAO-04-772 Medicare Hospital Outpatient Payments

are packaged and former pass-through devices cannot be evaluated, we 

believe that our more general recommendation allows the agency the 

flexibility to determine the most appropriate analyses for examining the 

rate-setting methodology.

With respect to the comment that the percentages of Medicare outpatient 

services accounted for by chemotherapy administration demonstrate that 

certain types of hospitals provide a disproportionate share of these 

services, we disagree. As noted in the draft report, we found that these 

percentages differ by type of hospital, but the differences are not 

substantial, as all types of hospitals provided a relatively small proportion 

of these services. No type of hospital provided a disproportionately large 

number of these services. We analyzed the proportion of services, rather 

than payments as industry representatives suggested, because we believe 

that is the better analysis for determining whether a certain type of hospital 

provides a disproportionate share of these services. We did not analyze the 

proportion of total services except for clinic services or the absolute 

number these services made up, as we do not believe such an analysis 

would accurately and comparably reflect potential differences between 

hospitals for all outpatient services they perform. 

The industry representatives also made technical comments, which we 

incorporated where appropriate.

We are sending a copy of this report to the Administrator of CMS. The 

report is available at no charge on GAO’s Web site at http://www.gao.gov. 

We will also make copies available to others on request.

If you or your staff have any questions, please call me at (202) 512-7119. 

Another contact and key contributors to this report appear in appendix IV.

Sincerely yours, 

A. Bruce Steinwald

Director, Health Care—Economic 

and Payment Issues
Page 23 GAO-04-772 Medicare Hospital Outpatient Payments

Appendix I

Scope and Methodology ApApenednxidexiIs

We analyzed Medicare claims data used by the Centers for Medicare & 

Medicaid Services (CMS) to set the 2003 outpatient prospective payment 

system (OPPS) payment rates. In addition, we analyzed drug average 

wholesale prices (AWPs), drug sources (sole-source, multi-source, or 

generic), and OPPS payment rates obtained from CMS. We interviewed 

officials at CMS and representatives from the American Hospital 

Association, Association of American Medical Colleges, Association of 

Community Cancer Centers (ACCC), Federation of American Hospitals, 

Greater New York Hospital Association, as well as from one large hospital 

system, one large hospital alliance, and five individual hospitals. In 

addition, we spoke with representatives from the Advanced Medical 

Technology Association, Biotechnology Industry Organization, California 

Healthcare Institute, Pharmaceutical Research and Manufacturers of 

America, as well as from seven drug manufacturers and three device 

manufacturers. We also spoke with consultants that advise hospitals on 

setting their charges. 

To compare payment for drugs to previous pass-through payments, we 

relied on information provided by CMS on drug sources and 2003 and 2004 

drug payment rates, and on CMS’s calculations of the AWPs for these drugs, 

which we supplemented with our own calculations. From CMS, we 

obtained the drug source and the payment rate for the 115 drugs and the 7 

drugs whose pass-through eligibility expired as of January 1, 2003 and 

January 1, 2004, respectively, that were assigned to separate ambulatory 

payment classification (APC) groups. We used Medicare’s January 2003 

and January 2004 Single Drug Pricer files to determine the 2003 and 2004 

AWPs, respectively, for most of the drugs. For the 37 drugs that were not 

included in the 2003 Single Drug Pricer file, we used the 2002 Drug Topics 

Red Book, published by Thomson Medical Economics, to calculate their 

AWPs. For the 2 drugs that were not in the 2004 Single Drug Pricer file, we 

used the 2003 Drug Topics Red Book, published by Thomson PDR, to 

calculate their AWPs. We calculated payment rates as a percentage of AWP 

for all drugs in 2003 and 2004. From our 2003 analysis, we excluded 1 

multi-source drug for which we calculated an AWP from the 2002 Drug 

Topics Red Book that was inconsistent with the 2002 AWP CMS provided to 

us and another multi-source drug with an AWP of $0.34, but a payment rate 

of almost 29,000 percent of that amount. 

To determine whether a particular type or types of hospitals provide a 

disproportionate number of outpatient services associated with drugs and 

devices, we used the outpatient claims file that CMS used to calculate the 
Appendix I

Scope and Methodology

Page 24 GAO-04-772 Medicare Hospital Outpatient Payments

2003 OPPS payment rates.1 To perform our own data reliability check of 

this file, we examined selected services to determine the reasonableness of 

their frequency in the data set, given the population of the beneficiaries 

receiving services and the setting in which they are delivered. We 

determined the data were reasonable for our purposes.

Using the claims, we determined which outpatient services were most 

often associated with drugs and devices and found that drugs were most 

often associated with chemotherapy administration services and devices 

were most often associated with cardiac services. Then, also using the 

claims, we compared proportions of chemotherapy administration and 

cardiac services for all hospitals, as well as for cancer center and 

noncancer center hospitals, major teaching and other hospitals, urban and 

rural hospitals, and hospitals with different outpatient service volumes.2

 

We included only those hospitals identified in CMS’s 2003 OPPS impact file, 

a data file CMS constructs to analyze projected effects of policy changes on 

various hospital groups, such as urban and rural hospitals. We excluded 

hospitals with fewer than 1,100 total outpatient services, or approximately 

3 outpatient services per day, as we believe such hospitals are not 

representative of most hospitals with outpatient departments. We defined 

cancer center hospitals as those hospitals that were members of ACCC as 

of February 28, 2003, the latest data available when we performed this 

analysis. We obtained the membership list from the ACCC. Using the 

September 2002 Medicare Provider of Services file and information 

obtained directly from the ACCC, we determined the Medicare provider 

numbers of ACCC members to identify claims billed by these hospitals. We 

defined major teaching hospitals as those hospitals having an 

intern/resident-to-bed ratio of 0.25 or more. We defined the urban or rural 

location of a hospital based on the urban/rural location indicator in the 

Medicare hospital OPPS impact file from calendar year 2003. We defined 

volume based on the number of services a hospital provided, also as 

1

 This data file contains claims for services performed from April 1, 2001 through March 31, 

2002.

2

 For both chemotherapy administration and cardiac services, we included in our analysis 

the procedure or administration codes associated with those services. We also included any 

chemotherapy or cardiac drugs that were assigned to their own APC for payment in 2003. 

We identified only separately paid drugs, and did not include packaged drugs, because the 

structure of the data file would have counted the packaged codes twice in our analysis – 

once with the procedure code and again if they were also listed separately on the claim. For 

the same reason we excluded all of the device codes from our analysis, as all devices that 

lost pass-through eligibility were packaged in 2003.
Appendix I

Scope and Methodology

Page 25 GAO-04-772 Medicare Hospital Outpatient Payments

indicated in the impact file. Small volume hospitals were those with fewer 

than 11,000 services, medium volume hospitals were those with at least 

11,000 services but fewer than 43,000 services, and large volume hospitals 

were those with at least 43,000 services. 

We interviewed representatives from hospitals, hospital associations, and 

drug and device manufacturers and the associations that represent them to 

obtain information about hospital charging practices. We received 

information on charge-setting practices from 5 hospitals whose officials we 

interviewed. We indirectly received information from 50 other hospitals 

through association and industry representatives with whom we spoke. 

Finally, we contacted seven state hospital associations in geographically 

diverse areas not well represented in our previous sample to identify their 

members’ charging practices. Some hospitals responded directly to us and 

others responded to their state association, which forwarded the responses 

to us. We received responses from 58 hospitals. The 113 hospitals from 

which we received information are not a statistically representative sample 

of all hospitals. 

We conducted our work from March 2003 through August 2004 in 

accordance with generally accepted government auditing standards.
Page 26 GAO-04-772 Medicare Hospital Outpatient Payments

Appendix II

Summary of Hospital Charge-Setting 

Methodologies ApendxiI

We received information from 113 hospitals, although not all hospitals 

responded to each question. Hospitals reported using a variety of methods 

to set the base charges for their clinic visit services (see table 3). To set the 

base charges for drugs, 25 of 57 hospitals responding reported that they 

used acquisition cost, 30 used the drug’s average wholesale price (AWP), 

and 2 used a combination of acquisition cost and AWP. To set the base 

charges for devices, 55 of 57 hospitals responding reported that they used 

acquisition cost. After setting base charges, 29 of 45 hospitals responding 

reported that they marked up all of their clinic visit services by the same 

percentage increase, although they reported using a variety of other 

methods as well. To mark up base charges for drugs and devices, most 

hospitals responding used either the same percentage for all drugs and for 

all devices, or used a graduated percentage markup, marking up low-cost 

items by a higher percentage (see table 4).

Table 3: Number and Percentage of Hospitals that Reported Methods for Setting 

Base Charges for Clinic Visit Services, 2003

Source: GAO.

Number Percentage

Cost of visit 13 29

Comparable charges in market 10 22

Medicare physician fee schedule 8 18

Cost of visit and comparable charges in market 4 9

Unspecified Medicare payment 3 7

Outpatient prospective payment system amount 

with an adjustment 1 2

Cost of visit and Medicare physician fee schedule 1 2

Unspecified Medicare payment and comparable 

charges 1 2

Other 4 9
Appendix II

Summary of Hospital Charge-Setting 

Methodologies

Page 27 GAO-04-772 Medicare Hospital Outpatient Payments

Table 4: Number and Percentage of Hospitals that Reported Methods to Mark Up 

Drug and Device Charges, 2003

Source: GAO.

a

Percentage of total hospitals responding does not total 100 percent due to rounding. 

In addition, 24 of the 57 hospitals responding reported that they include 

nonproduct costs as a portion of their drug charges, and 25 of 57 

responding reported that they include nonproduct costs as a portion of 

their device charges. The most common nonproduct costs included were 

administrative and overhead costs. Of the 24 including nonproduct costs in 

drug charges, 12 reported that they do so by adding an additional 

percentage of the drug acquisition cost to the drug charge. Of the 25 

including nonproduct costs in device charges, 16 reported that they do so 

by adding an additional percentage of the device acquisition cost to the 

device charge. However, the amount of the nonproduct costs as a 

percentage of the charges varied widely among hospitals. Of the 24 

hospitals including nonproduct costs in drug charges, 16 reported that the 

amount varied by the route of administration for the drug, such as 

intravenous or intramuscular administration. 

Of the 58 hospitals responding, all reported that they update their charges 

for inflation; 40 reported they did so annually, 12 did so at other times, and 

6 did so both annually and at other times. While many used a standard 

across-the-board percentage increase to update their charges, the majority 

used other methods. In addition, 33 of the 57 hospitals responding reported 

that they exclude certain charges from these updates. The types of 

services whose charges they excluded, such as drug, laboratory, and room 

charges, varied widely. Finally, 49 of 58 hospitals responding reported that 

they periodically review all their charges. 

Drugs Devices

Number Percentage Number Percentagea

Same percentage for all items 40 43 39 46

Graduated percentage, 

higher for low-cost items 33 36 39 46

Graduated percentage, 

lower for low-cost items 6 7 4 5

Other 13 14 3 4
Page 28 GAO-04-772 Medicare Hospital Outpatient Payments

Appendix III

Comments from the Centers for Medicare & 

Medicaid Services ApendxiI
Appendix III

Comments from the Centers for Medicare & 

Medicaid Services

Page 29 GAO-04-772 Medicare Hospital Outpatient Payments
Appendix III

Comments from the Centers for Medicare & 

Medicaid Services

Page 30 GAO-04-772 Medicare Hospital Outpatient Payments
Appendix III

Comments from the Centers for Medicare & 

Medicaid Services

Page 31 GAO-04-772 Medicare Hospital Outpatient Payments
Appendix III

Comments from the Centers for Medicare & 

Medicaid Services

Page 32 GAO-04-772 Medicare Hospital Outpatient Payments
Page 33 GAO-04-772 Medicare Hospital Outpatient Payments

Appendix IV

GAO Contact and Staff Acknowledgments ApendxiIV

GAO Contact Nancy A. Edwards, (202) 512-3340

Acknowledgments Beth Cameron Feldpush, Joanna L. Hiatt, Maria Martino, and Paul M. 

Thomas made major contributions to this report. 

(290290)
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