GAO-06-17R Comments on Proposed 2006 SCOD Rates 

United States Government Accountability Office

Washington, DC 20548 

October 31, 2005 

The Honorable Charles E. Grassley 

Chairman 

The Honorable Max Baucus 

Ranking Minority Member 

Committee on Finance 

United States Senate 

The Honorable Joe Barton 

Chairman 

The Honorable John D. Dingell 

Ranking Minority Member 

Committee on Energy and Commerce 

House of Representatives 

The Honorable William M. Thomas 

Chairman 

The Honorable Charles B. Rangel 

Ranking Minority Member 

Committee on Ways and Means 

House of Representatives 

Subject: Medicare: Comments on CMS Proposed 2006 Rates for Specified Covered 

 Outpatient Drugs and Radiopharmaceuticals Used in Hospitals 

On July 25, 2005, the Centers for Medicare & Medicaid Services (CMS) in the 

Department of Health and Human Services (HHS) published its notice of proposed 

rulemaking (NPRM) entitled “Medicare Program; Proposed Changes to the Hospital 

Outpatient Prospective Payment System and Calendar Year 2006 Payment Rates.”1

 As 

part of these changes, CMS is proposing Medicare payment rates for certain hospital 

outpatient drugs—classified for payment purposes as specified covered outpatient 

drugs (SCOD). The Medicare Prescription Drug, Improvement, and Modernization 

Act of 2003 (MMA) defined a SCOD as a drug or radiopharmaceutical used in hospital 

outpatient departments, covered by Medicare, and paid for individually rather than as 

part of a payment group with other services.2

 

1

70 Fed. Reg. 42,674. 

2

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

§ 1395l(t)(14)(B)). 
2 GAO-06-17R Comments on Proposed 2006 SCOD Rates

 

With regard to SCODs, the MMA directed CMS to set 2006 payment rates equal to 

hospitals’ average acquisition costs—the cost to hospitals of acquiring a product, net 

of rebates.3

 In several related requirements, the MMA directed us to provide 

information on SCOD costs and CMS’s proposed rates.4

 First, we were required to 

conduct a survey of hospitals to obtain data on their acquisition costs of SCODs and 

provide information based on these data to the Secretary of Health and Human 

Services for his consideration in setting 2006 Medicare payment rates. We provided 

information from this survey in two reports5

—one on drugs and biologicals, and 

another on radiopharmaceuticals.6 These reports presented systematic information 

on hospitals’ purchase prices of SCODs and limited information on rebates. Second, 

we were required to evaluate CMS’s proposed rates for SCODs and comment on their 

appropriateness in light of the survey of SCOD prices we conducted.7 

In response to the second requirement, this report assesses the appropriateness of 

the Medicare payment rates that CMS has proposed for SCODs, taking into account 

the purchase prices obtained from the MMA-mandated survey we conducted in 2004 

and 2005. Specifically, this report focuses on the appropriateness of CMS’s proposed 

2006 hospital outpatient rates for (1) drug SCODs and (2) radiopharmaceutical 

SCODs. To conduct this assessment, we examined the information CMS provided in 

the proposed rule on the data sources and methodology used to set the 2006 rates, 

analyzed this information in light of our survey of hospitals’ purchase prices, and 

3

Specifically, the MMA required that payment rates equal the average acquisition costs as determined 

by the Secretary of Health and Human Services, unless hospital acquisition cost data are not available. 

If such data are not available, the law permitted payment rates to equal one of several amounts, 

including average sales price, as calculated and adjusted by the Secretary. MMA 117 Stat. 2307. 

4

MMA 117 Stat. 2308—09. The law also required the Medicare Payment Advisory Commission 

(MedPAC) to report on overhead and related expenses (such as pharmacy services and handling costs) 

and authorized the Secretary of Health and Human Services to adjust the SCOD rates for these costs. 

MMA 117 Stat. 2309. See ch. 6, “Payment for pharmacy handling costs in hospital outpatient 

departments,” in MedPAC’s mandated report, Issues in a Modernized Medicare Program

(Washington, D.C.: June 2005). 

5

GAO, Medicare: Drug Purchase Prices for CMS Consideration in Hospital Outpatient Rate Setting, 

GAO-05-581R (Washington, D.C.: June 30, 2005), and GAO, Medicare: Radiopharmaceutical Purchase 

Prices for CMS Consideration in Hospital Outpatient Rate Setting, GAO-05-733R (Washington, D.C.: 

July 14, 2005). 

6

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

from living sources, including humans, animals, and microorganisms. Radiopharmaceuticals are 

radioactive substances used for diagnostic or therapeutic purposes. 

7

The MMA also required us to report on differences in SCOD acquisition costs by type of hospital and 

recommend future data collection methods, taking into account our experience. We will address these 

issues in a future report. 
3 GAO-06-17R Comments on Proposed 2006 SCOD Rates

 

convened an expert panel to review our findings.8 Consistent with the MMA, we did 

not study the issue of hospitals’ handling costs for SCODs and do not address these 

costs in this report. We performed our work according to generally accepted 

government auditing standards from July through October 2005. 

Results in Brief 

We consider CMS’s selection of a data source------average sales price (ASP)------for use in 

setting Medicare’s hospital outpatient rates for drug SCODs to be practical, given 

available alternatives, but we consider CMS’s proposed 2006 rates for drug SCODs to 

be excessive. 

CMS proposes to base its 2006 drug SCOD rates on manufacturers’ ASP data, setting 

rates at ASP+6 percent. ASP is a composite measure of the average price of a 

SCOD------net of discounts, rebates, and other price concessions------paid by all 

purchasers, not just hospitals. Manufacturers report this information quarterly. In 

our view, ASP is a practical data source, providing the most timely publicly available 

data on prices of drug SCODs. However, we have two concerns about setting the 

proposed drug SCOD rates: 

• As a composite measure, ASP is a black box, lacking the detail CMS needs to 

validate the reasonableness of the data underlying the reported prices. Without a 

breakdown of price data showing rebates and other components as well as 

average prices by purchaser type, CMS cannot ensure that ASPs accurately reflect 

average acquisition costs by hospital purchasers alone. 

• CMS does not provide a convincing rationale for proposing a rate 6 percent higher 

than ASP. CMS’s analysis indicates that ASP+6 percent will exceed hospitals’ 

acquisition costs. CMS states that the prices reported in our survey------that is, the 

average prices hospitals paid for drug SCODs (which do not net out rebates 

received at a later time)------equal ASP+3 percent. Logically, acquisition costs, 

which do net out rebates from purchase prices, would equal an amount less than 

ASP+3 percent. Therefore, our survey data and CMS’s analysis of these data 

indicate that a rate set at or above ASP+3 percent is not appropriate, given that it 

would exceed the hospitals’ average acquisition cost. 

Similarly, we are concerned that CMS’s proposed 2006 rates for radiopharmaceutical 

SCODs will, on average, exceed hospitals’ acquisition costs. CMS chose to use cost 

estimates developed from hospital charges rather than survey data on the prices 

hospitals reported paying for radiopharmaceuticals. However, as we have previously 

8

The panelists were Joseph P. Newhouse, John D. MacArthur Professor of Health Policy and 

Management, Harvard University; Robert A. Berenson, Senior Fellow, Urban Institute; Ernst R. Berndt, 

Professor of Applied Economics, Sloan School of Management, Massachusetts Institute of Technology; 

Andrea G. Hershey, Clinical Coordinator and Pharmacy Residency Program Director, Union Memorial 

Hospital (Baltimore, Md.); and Richard L. Valliant, Senior Research Scientist, University of Michigan. 
4 GAO-06-17R Comments on Proposed 2006 SCOD Rates

reported,9 the methodology for estimating costs from charges results in significant 

imprecision. CMS states that it intends to set rates for radiopharmaceutical SCODs 

that are consistent with previous years’ payment rates, even though the MMA does 

not establish such a criterion. ASPs are not available for radiopharmaceuticals for 

2006 rate setting, but CMS plans to get this information from manufacturers for future 

years’ rates. 

In light of our assessment that CMS’s proposed rates are higher than can be justified, 

we are recommending that the Secretary of Health and Human Services reconsider 

the level at which HHS has proposed to set drug SCOD rates, reconsider its reliance 

on charge-based cost estimates in setting radiopharmaceutical SCOD rates, and 

collect more detailed information on ASPs. In written comments on a draft of this 

report, CMS stated that it is considering our recommendations as it prepares the final 

rule on the OPPS for 2006. 

Background 

The relationship of SCODs to the outpatient prospective payment system (OPPS) and 

the distinctions among acquisition costs, prices, and related terms provide a context 

for interpreting CMS’s proposed 2006 rates for SCODs and the agency’s discussion of 

these rates in the NPRM. 

Hospital Outpatient Payment System and SCODs

The recent history of Medicare’s rate setting for hospital outpatient department 

services forms a backdrop for our comments on the proposed SCOD payment rates. 

Specifically, CMS uses OPPS to pay hospitals for services that Medicare beneficiaries 

receive as part of their treatment in hospital outpatient departments. Under OPPS, 

Medicare pays hospitals predetermined rates for most services. 

When OPPS was first developed as required by the Balanced Budget Act of 1997,10

 the 

OPPS rates for hospital outpatient services, drugs, and radiopharmaceuticals were 

based on hospitals’ 1996 median costs. However, these rates prompted concerns that 

payments to hospitals would not reflect the costs of newly introduced 

pharmaceutical products used to treat, for example, cancer, rare blood disorders, and 

other serious conditions. In turn, congressional concerns were raised that 

beneficiaries might lose access to some of these products if hospitals avoided 

providing them because of a perceived shortfall in payments. In response to these 

concerns, the Medicare, Medicaid, and SCHIP Balanced Budget Refinement Act of 

1999 authorized pass-through payments, which were a way to temporarily augment 

the OPPS payments for newly introduced pharmaceutical products first used after 

1996.11 The MMA modified this payment method for some of these pharmaceutical 

 

9

GAO, Medicare: Information Needed to Assess Adequacy of Rate-Setting Methodology for Payments 

for Hospital Outpatient Services, GAO-04-772 (Washington, D.C.: Sept. 17, 2004). 10Pub. L. No. 105-33, § 4523, 111 Stat. 251, 445—50. 

11Pub. L. No. 106-113, app. F, § 201(b), 113 Stat. 1501A-321, 1501A-337—1501A-339. 
5 GAO-06-17R Comments on Proposed 2006 SCOD Rates

products.

12

 As part of the modification, the MMA defined the new SCOD payment

category, which includes many of these newly introduced pharmaceutical products. 

Acquisition Costs, Purchase Prices, Discounts, and Rebates

Hospital acquisition costs—the level at which CMS is directed to set payment rates 

for SCODs—cannot be directly observed from price data alone. Hospitals can buy 

pharmaceutical products directly from manufacturers or from other vendors, namely 

wholesalers and distributors.

13 Hospitals may receive discounts or rebates or both. 

Discounts are price concessions given by manufacturers or wholesalers that are 

reflected in the purchase price—the price hospitals pay at the time of delivery. 

Rebates are price concessions given to hospitals by manufacturers subsequent to

receipt of the product. The acquisition cost to hospitals is the difference between the 

purchase price paid at the time of a product’s delivery and any rebates given by the 

manufacturer after hospitals receive the product. (See fig. 1.) As a result of rebates, 

a hospital’s acquisition cost for a product may be lower than the purchase price. 

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

Note: Numbers are hypothetical.

Both discounts and rebates depend on a hospital’s purchasing patterns. 

Manufacturers’ discounts and rebates may be based on a hospital’s purchase volume

of a drug or on its market share—the percentage of a certain type of drug bought 

from a single manufacturer. In some cases, rebates are based on a purchaser’s

volume or market share of a set, or bundle, of products defined by the manufacturer. 

This bundle may include more than one drug or a mixture of drugs and other 

products, such as bandages and surgical gloves. Hospitals can also receive “prompt 

pay” discounts when they pay in advance or within a prescribed time period.14

 

 12MMA 117 Stat. 2307—10. 13Wholesalers and distributors perform related functions, and the two terms are often used

interchangeably. We refer to both wholesalers and distributors as wholesalers. 

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

period.
6 GAO-06-17R Comments on Proposed 2006 SCOD Rates

In contrast to purchase price and acquisition cost, which are common business and

economic terms, ASP is a price measure established in law and used by CMS. This 

price measure is used to set payment rates for drugs administered in physician offices 

and covered under part B of Medicare. CMS instructs pharmaceutical manufacturers 

to report ASP data to CMS within 30 days after the end of each quarter. The MMA 

defined ASP as the average sales price for all U.S. purchasers15 of a drug, net of 

volume, prompt pay, and cash discounts; free goods contingent on a purchase 

requirement; and charge-backs and rebates.16

CMS’s Proposed Rule to Pay for

SCOD Products in 2006

Under the MMA, payment for SCODs in 2006 is required to be equal to the average 

acquisition cost for the drug as determined by the Secretary of Health and Human 

Services, taking into account the hospital acquisition cost survey data we collected in 

2004 and 2005.17 

CMS has issued an NPRM that, along with other matters relating to the OPPS, 

describes the way it proposes to implement the MMA requirements on SCOD 

payment rates. CMS will receive comments from interested organizations and 

individuals, consider these comments, and publish a final rule—which may differ in 

some particulars from the proposed rule—later in 2005. To establish the proposed 

rates, CMS made two primary decisions for both drug SCODs and 

radiopharmaceutical SCODs: the data source to use and the level at which the rates 

should be set. 

Data for Drug SCODs 

CMS considered three possible data sources—purchase prices from our survey, 

Medicare charges, and ASP; it selected ASP. The NPRM noted two problems with the 

purchase price data: (1) prices could have increased since the end of the time period 

for which they were collected—July 2003 through June 2004—and (2) the data did 

not take into account rebates and similar price concessions. The problem cited with 

the Medicare charge data was that charges include both acquisition costs and 

handling costs. Because of the inclusion of handling costs, CMS concluded that 

Medicare charges were not an acceptable proxy for acquisition costs. The NPRM 

 

15MMA 117 Stat. 2240—41. Certain prices, including prices paid by federal purchasers and prices for 

drugs furnished under the Medicare prescription drug discount card program, are excluded. In the 

future, prices for drugs furnished under Medicare part D, the prescription drug benefit, will also be 

excluded. 

16A charge-back is a payment by a manufacturer to a wholesaler that is made when the wholesaler’s 

price to a hospital is lower than the price the wholesaler initially paid the manufacturer. Charge-back 

arrangements occur when hospitals have negotiated lower prices from the manufacturer, often 

through a group purchasing organization. All but Medicaid rebates are deducted in the manufacturer’s 

calculation of ASP. Under the Medicaid program, manufacturers are required to pay rebates to states 

for prescription drugs covered by state Medicaid programs. 

17MMA 117 Stat. 2307. 
7 GAO-06-17R Comments on Proposed 2006 SCOD Rates

 

stated that ASP-based payment rates served as the best proxy for average acquisition 

costs because the manufacturers’ sales prices from the last quarter of 2004 provided 

the most recent data available. 

Rates for Drug SCODs 

CMS considered setting the rates at three levels: ASP+3 percent, ASP+6 percent, and 

ASP+8 percent; it selected ASP+6 percent.18 CMS considered ASP+3 percent because, 

on average, it was equal to the purchase price obtained from our survey. It 

considered ASP+8 percent because, on average, it was equal to an estimate of cost 

based on charges.19 CMS did not use either of these options because of its concerns 

about using the purchase prices from our survey and the charges from Medicare 

claims as data sources. CMS arrived at a hospital drug SCOD rate of ASP+6 percent 

by eliminating the other two options. The NPRM mentioned that ASP+6 percent is 

also the rate that Medicare pays physicians for drugs. 

Data for Radiopharmaceutical SCODs 

CMS considered two data sources for radiopharmaceutical rates: survey results on 

purchase prices and Medicare charges; it selected Medicare charges.20 ASP was not 

an option because ASP has not been collected for radiopharmaceuticals. (For 

payment rates in 2007 and future years, CMS plans to collect ASP for 

radiopharmaceuticals.) CMS elected not to use the survey results on purchase prices 

because, in comparing the purchase prices of the nine radiopharmaceuticals in the 

GAO data to CMS’s 2005 payment rates, it found that “the GAO purchase prices were 

substantially lower for several of these agents.” Similarly, the Medicare charge data 

yielded estimated costs lower than the 2005 payment rates. CMS selected the 

Medicare charge data, noting that charges are believed to cover both acquisition costs 

and handling costs, so these data could be used to set a payment rate that covered 

both. 

Rates for Radiopharmaceutical SCODs 

Having selected the charge data, CMS had only one option: to use the charges to 

estimate costs for setting radiopharmaceutical SCOD rates. For each 

radiopharmaceutical SCOD, it proposed adjusting the hospital charges to a hospitalspecific estimate of costs. These estimates of cost would include both acquisition 

costs and handling costs. CMS stated that it intended to maintain consistency 

whenever possible between the payment rates in 2005 and 2006, because such “rapid 

1870 Fed. Reg. 42,724—27. 

19To estimate the cost of a SCOD, CMS multiplied hospital charges for the SCOD by a ratio of hospital 

costs to hospital charges. 

2070 Fed. Reg. 42,727—28. 
8 GAO-06-17R Comments on Proposed 2006 SCOD Rates

reductions” could adversely affect beneficiary access to services utilizing 

radiopharmaceuticals.21

Adjustments to Rates for Overhead 

Under the MMA, the Medicare Payment Advisory Commission (MedPAC) was 

required to report on adjusting SCOD payments to take account of overhead and 

related expenses, such as pharmacy services and handling costs, and the Secretary 

may adjust payment rates to take into account MedPAC’s recommendations.22 For 

drugs, the proposed regulation provides for increasing the payment for drug 

acquisition costs by 2 percent of ASP to cover overhead and handling, resulting in a 

total payment for drugs of ASP+6 percent+2 percent. According to CMS, costs 

calculated from charges equal ASP+8 percent. Since it has determined that 

acquisition costs are equal to ASP+6 percent, and since pharmacy overhead costs are 

built into the charges, CMS concluded that the difference between charge-based costs 

(equal to ASP+8 percent) and acquisition costs (which CMS states equal ASP+6 

percent) is the overhead adjustment. Consequently, it proposed to set the overhead 

adjustment at 2 percent of ASP. 

For radiopharmaceuticals, CMS has chosen to use charge-based costs. Since these 

costs appear to include overhead, CMS concluded that no further adjustment for 

overhead is required. 

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

SCODs. 

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

Alternatives that CMS considered 

(CMS decision in italics) 

Drug SCODs 

• Data source ASP 

Purchase pricesa

Cost estimated from claims data 

• Rates ASP+3 percent 

ASP+6 percent b

ASP+8 percent 

Radiopharmaceutical SCODs 

• Data source Purchase pricesa

Cost estimated from claims data 

• Rates Average purchase price 

Cost estimated from chargesc 

Source: GAO analysis of CMS proposed rule. 

a

Calculated by GAO from its hospital survey data. 

b

CMS also proposed an additional 2 percent of ASP to cover hospitals’ overhead and handling costs for drug 

SCODs. 

c

The rate includes hospitals’ overhead and handling costs. 

 

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

2270 Fed. Reg. 42,728-29. For MedPAC’s report and recommendations, see Issues in a Modernized 

Medicare Program, ch. 6. 
9 GAO-06-17R Comments on Proposed 2006 SCOD Rates

ASP Is Reasonable as Data Source for 

Setting Rates, but ASP+6 Percent Is 

Excessive Relative to Hospitals’ Acquisition Costs 

The results from our survey of hospitals’ purchases of drug SCODs suggest that the 

data source on which CMS proposes to base its rate-setting is reasonable, but the 

proposed rate is too high. For several practical reasons, ASP is an acceptable data 

source for setting drug SCOD rates, given the challenges of collecting drug price data. 

However, without more information on the data used to construct ASP, CMS cannot 

determine if this blend of average prices paid by all U.S. purchasers—not just 

hospitals—measures the prices paid by hospitals alone with sufficient accuracy. In 

addition, CMS’s proposal to set the 2006 payment rate 6 percent above ASP is 

excessive and inconsistent with setting payment rates equal to acquisition costs. 

ASP Practical as Data Source, but Accuracy

Could Be Affected by Certain Information Gaps

CMS’s decision to use ASP data is practical for four reasons. First, ASP at least 

roughly approximates hospital acquisition costs of drug SCODs.23 Second, the use of 

ASP does not entail data collection start-up costs for CMS or manufacturers, as CMS 

uses an ASP-based methodology to pay for drugs in the physician office setting. 

Third, ASP is the most recent publicly available price information: it is based on data 

submitted by manufacturers 30 days after the close of each quarter. In contrast, an 

alternative method to ASP—conducting surveys of hospitals—would likely be costly, 

present challenges to hospitals’ information system capabilities, and require a lengthy 

period for data collection and processing.24 Fourth, ASP takes account of rebates, 

which we found were difficult for hospitals to report, and therefore we did not deduct 

them from our estimates. 

Notwithstanding these advantages, information gaps remain that render ASP a “black 

box” in terms of its constituent components. For example, in reporting ASP data to 

CMS, manufacturers do not break out ASP price components, such as rebates and 

other price concessions.25 CMS instructs manufacturers to deduct components such 

as rebates in calculating ASP, but lacking a price breakdown—or an independent 

 

23Because purchase price is the largest component of acquisition costs, and purchase cost is equal to 

ASP+3 percent, it follows that ASP roughly approximates acquisition costs. Purchase price is highly 

correlated with ASP for drug SCODs (r = .9978). 

24For example, our methodology, consistent with statutory requirements, entailed considerable start-up 

and logistical costs as well as a substantial period for data collection. The MMA required that we 

obtain price information from hospitals, not manufacturers, and that the sample of hospitals be “large.” 

Our survey included over 1,000 hospitals with a wide range of capabilities to provide needed data 

promptly. Fielding the survey required a commitment of substantial resources. In addition, hospitals 

had to expend considerable effort to identify, compile, and transmit purchase price data, making the 

potential for frequent data collection through hospital surveys problematic. 

25The only information regarding price that CMS requires is the product’s ASP. Nonprice information 

that manufacturers must report consists of the manufacturer’s name, the product’s National Drug 

Code, and the number of units. 
10 GAO-06-17R Comments on Proposed 2006 SCOD Rates

source of price and rebate data—the agency cannot assess whether rebates and other 

components were appropriately excluded or whether the amount of any exclusions 

was plausible. In addition, information about the basis on which manufacturers 

calculate rebates would be useful. Collecting price breakdowns and related 

information would allow CMS to assess the reasonableness of the data underlying the 

reported prices. 

In addition, because ASP is an average of prices paid for a product by all U.S. 

purchasers, it lacks sufficient detail for estimating acquisition costs of hospitals in 

particular. ASP data are not compiled by purchaser type—such as hospital outpatient 

department, physician office, retail pharmacy, or wholesaler. Thus, ASP does not 

permit CMS to distinguish between prices paid by hospitals and those paid by other 

end purchasers. The net effect of averaging all sales into one price is to weaken ASP 

as an accurate indicator of acquisition costs for hospitals alone. 

Rationale Unconvincing for CMS’s Proposed Rates, Which 

Would Pay Hospitals More Than Their Acquisition Costs

CMS proposes to set payments for drug SCODs at ASP+6 percent, but the questions 

that arise from setting rates at this level are not answered by the agency’s analysis. 

As CMS notes, the MMA requires that the agency’s determination of average 

acquisition costs take into account our mandated survey of prices hospitals paid for 

SCOD products. According to CMS, our survey’s purchase prices on average equal 

ASP+3 percent,26 and we and CMS agree that these purchase prices do not account for 

any after-purchase rebates that would lower the product’s actual cost to the hospital. 

Logically, then, for payment rates to equal acquisition costs, CMS would need to set 

rates lower than ASP+3 percent, taking our survey data into account. We could not 

determine how much lower the rates should be set, as neither we nor CMS were able 

to systematically quantify the magnitude of rebates or other price concessions as a 

percentage of a product’s purchase price or ASP. In effect, ASP+3 percent is the 

upper bound of acquisition costs—that is, acquisition costs should be less than 

ASP+3 percent. Consistent with our reasoning, CMS notes that “Inclusion of these 

rebates and price concessions in the GAO data would decrease the GAO prices 

relative to the ASP prices, suggesting that ASP+6 percent may be an overestimate of 

hospitals' average acquisition costs.” 

Nevertheless, CMS did not propose to set rates at less than ASP+3 percent. It 

suggests that SCOD prices may have increased from the June 30, 2004, end point of 

the time period for which hospitals submitted survey data. However, neither data 

from our survey of purchase prices nor CMS’s quarterly ASP data support the 

agency’s concerns about potential drug price increases. Specifically: 

• Between the first and last quarters for which we collected survey data, purchase 

prices for drug SCODs decreased slightly—falling by about 1 percent, on average. 

 

26Our purchase prices do not uniformly equal ASP+3 percent. For example, for several drug SCODs, 

the purchase price is approximately equal to ASP. 
11 GAO-06-17R Comments on Proposed 2006 SCOD Rates

 

• CMS found that, between the fourth quarter of 2004 and the first quarter of 2005, 

ASP declined, on average, by 2 percent. CMS officials also told us that, between 

the third and fourth quarters of 2004, the trend in the average ASP for drug SCODs 

was relatively flat or slightly downward. 

The lack of evidence for SCOD drug price inflation—coupled with CMS’s calculation 

that hospitals’ acquisition costs on average are lower than purchase prices 

(equivalent to ASP+3 percent)—show that a rate for SCOD drugs of ASP+6 percent 

would be too high. In the NPRM, CMS notes that it proposes to pay for drug SCODs 

at the payment rates used for drugs used in physician offices and suggests that a 

“consistency of drug pricing between physician offices and hospital outpatient 

departments” would be desirable. However, CMS does not show evidence that 

acquisition costs are similar for the two provider types. 

CMS’s Estimates of Hospitals’ Costs for 

Radiopharmaceuticals Do Not Utilize 

Available Data on Actual Prices Paid 

and May Be Excessive 

CMS’s proposed rates for radiopharmaceutical SCODs are cost estimates based on 

charges and, although ASP data are not available for radiopharmaceuticals, do not 

utilize available survey data on actual prices paid for these products. In addition, the 

proposed rates may be excessive. 

Historically, CMS has not directed manufacturers to report ASPs for 

radiopharmaceuticals. Lacking these data, CMS proposes to set 2006 rates for 

radiopharmaceutical products equal to its estimates of the costs to hospitals of 

acquiring and handling these products. To obtain these cost estimates, CMS converts 

charges to costs using a ratio that applies to all of a hospital’s expenses and is not 

specific to radiopharmaceuticals. In calculating this ratio, CMS will use the most 

recent data available on costs, which likely will be for 2004. 

CMS contends that its estimated costs are the best available proxy for the average 

acquisition cost of a radiopharmaceutical and include its handling cost. It states that 

hospitals’ different purchasing, preparation, and handling practices for 

radiopharmaceuticals are reflected in hospitals’ charges, which can be converted to 

costs using hospital-specific cost-to-charge ratios. In the absence of actual 

transaction data, this method would be reasonable though imperfect. At best this 

method is subject to significant imprecision. The charge-setting methodologies of 

hospitals and departments within hospitals vary considerably, whereas CMS’s cost-tocharge calculations assume uniformity.27 In contrast, we collected transaction data 

for our recent reports.28 Our survey data included purchase prices on nine key 

radiopharmaceutical SCODs—accounting for over 90 percent of Medicare spending 

27See GAO, Medicare: Information Needed to Assess Adequacy of Rate-Setting Methodology for 

Payments for Hospital Outpatient Services, GAO-04-772 (Washington, D.C.: Sept. 17, 2004). 

28GAO-05-581R and GAO-05-733R. 
12 GAO-06-17R Comments on Proposed 2006 SCOD Rates

 

on all radiopharmaceutical SCODs. These purchase prices are averages of the actual 

prices that hospitals paid. As a result, the average purchase prices approximate 

hospitals’ acquisition costs more closely than the charge-based estimates CMS has 

proposed. Unlike purchase prices for drugs, purchase prices for most 

radiopharmaceuticals are likely to be equivalent to acquisition costs, as rebates are 

not commonly paid for radiopharmaceuticals. Regarding the radiopharmaceutical 

SCODs for which purchase price data are not available and which account for less 

than 10 percent of Medicare spending on radiopharmaceutical SCODs, CMS’s 

proposed charge-based method of estimating costs is reasonable in setting 2006 rates. 

CMS does not rely on the purchase prices from our survey in setting rates for 

radiopharmaceutical SCODs. It contends that the average purchase prices developed 

from our survey for some radiopharmaceutical SCODs are not suitable because these 

prices were substantially lower than CMS’s payment rates for these SCODs in 2005.29 

However, this relationship to payment rates is also true for CMS’s estimated costs of 

radiopharmaceutical SCODs, based on charges found in hospital claims data—the 

method selected in CMS’s proposed rule. CMS states that it wants to maintain 

consistency between 2005 and 2006 payment rates and is concerned that “rapid 

reductions” in payment rates could adversely affect access to radiopharmaceuticals. 

As with purchase prices, CMS also found that for several radiopharmaceuticals its 

estimated costs based on charges were lower than CMS’s 2005 payment rates. 

However, CMS did not explain why, despite their similar relationship to the payment 

rates, the estimated costs from claims data were preferable to the actual purchase 

prices for key radiopharmaceutical SCODs. 

Nonetheless, maintaining consistency with 2005 rates is a questionable goal, since the 

MMA directed CMS to pay SCODs an amount equal to acquisition costs and did not 

mention other goals. Moreover, this relationship suggests that some of CMS’s 2005 

payment rates were excessive relative to the actual costs hospitals incurred to 

acquire these products, thereby refuting CMS’s contention that “rapid reductions” in 

2006 payment rates (based on average purchase price) could reduce beneficiary 

access to services using radiopharmaceuticals. Furthermore, in light of the tendency 

CMS noted for 2005 rates to exceed purchase prices, we are concerned that payment 

rates for radiopharmaceutical SCODs for 2006 may also be too high. 

Conclusions 

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

• First, ASP is a black box, which does not permit CMS to ensure the 

reasonableness of the data underlying the drug SCOD rates. While CMS’s 

selection of ASP as a data source for drug SCODs is reasonable, given the 

alternatives, additional information to validate ASP is needed to assess the 

accuracy of these data in approximating hospitals’ acquisition costs. A 

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

prices. 
13 GAO-06-17R Comments on Proposed 2006 SCOD Rates

breakdown of ASP by hospitals and other purchaser types would enable CMS to 

determine if ASP—a blend of prices paid by wholesalers and various end 

purchasers—closely approximates the prices paid by hospitals alone. A separate 

breakdown of ASP by rebates and other components would enable CMS to assess 

whether the magnitudes of the various components are reasonable and to confirm 

that they are taken into account appropriately in calculating ASPs. 

• Second, the proposed rates for drug SCODs are too high because their level 

exceeds hospitals’ acquisition costs. To approximate hospitals’ acquisition costs, 

average purchase prices—estimated by CMS to equal ASP+3 percent—would 

need to be reduced by some unknown magnitude to account for rebates. Instead, 

CMS’s proposed rate—ASP+6 percent—is higher than the average purchase price, 

for reasons that CMS does not convincingly explain. 

For setting radiopharmaceutical SCOD rates, CMS proposes to rely on charge-based 

estimates of cost, which are likely to be inaccurate measures of acquisition costs, and 

dismisses available purchase price data, which cover products accounting for more 

than 90 percent of Medicare’s expenditures for hospital outpatient 

radiopharmaceuticals. CMS’s proposed 2006 rates for radiopharmaceutical SCODs 

are likely to exceed hospitals’ acquisition costs. CMS relies on cost estimates rather 

than available data on actual purchase prices. CMS declined to use our purchase 

prices for the proposed 2006 radiopharmaceutical SCOD rates because it found that 

our prices were substantially lower than CMS’s 2005 payment rates. However, the 

fact that 2005 payment rates were higher—or lower—than the purchase prices 

hospitals paid for key radiopharmaceutical SCODs only reveals weaknesses in the 

payment rates. 

Paying hospitals’ acquisition costs and no more should be the aim that drives CMS’s 

rate-setting calculations for SCODs. For drug SCODs, CMS proposes rates that are 

too high, while for radiopharmaceutical SCODs, the agency has declined to set rates 

equal to an available measure of acquisition costs. 

Recommendations for Executive Action 

We recommend that, to better approximate hospitals’ acquisition costs of SCODs, the 

Secretary of Health and Human Services take three actions: 

• Reconsider the level of proposed payment rates for drug SCODs, in relation 

to survey data on average purchase price, the role of rebates in determining 

acquisition costs, and the desirability of setting payment rates for SCODs 

at average acquisition costs. 

• Reconsider the decision to base payment rates for radiopharmaceutical 

SCODs exclusively on estimated costs, in light of the availability of data on 

actual prices paid for key radiopharmaceuticals. 
14 GAO-06-17R Comments on Proposed 2006 SCOD Rates

• Collect information on ASP components and ASP by purchaser type to

validate the reasonableness of reported ASPs as a measure of hospital 

acquisition costs. 

Agency Comments and Our Evaluation 

In written comments on a draft of this report, CMS summarized our analyses of its

proposed method and payment rates for SCODs. (We reprinted CMS’s comments in 

enclosure I of this report.) CMS stated that it is considering our recommendations as

it prepares the final rule on the OPPS for 2006. In particular, CMS expressed 

appreciation for our analysis of the data sources it considered in the NPRM and noted 

our concern that because of information gaps, CMS cannot ensure that ASPs 

accurately reflect hospitals’ acquisition costs. CMS affirmed its commitment to 

ensuring that SCOD payment rates equal hospitals’ average acquisition costs, as 

required by law, and cited our finding that ASP+3 percent should be a ceiling on

payment rates. However, our finding was that ASP+3 percent is the upper bound on

acquisition costs; therefore we have revised our report to clarify that payment rates 

should be less than the ceiling. With respect to radiopharmaceutical SCODs, CMS 

expressed appreciation for our analysis and noted our concern that CMS’s proposed 

charge-based rates would overpay hospitals for these products. CMS also noted our 

recommendation to collect additional information on ASP to validate the 

reasonableness of reported ASPs, saying that it would consider the feasibility of the 

recommendation. 

Our recommendations seek to ensure that the payment rates Medicare sets for 

SCODs equal hospitals’ average acquisition costs and that these average costs are 

measured as accurately as possible. We reiterate the importance of taking our 

recommendations into account in preparing the final rule. 

- - - - - 

We are sending copies of this report to the Secretary of Health and Human Services

and the Administrator of CMS. The report is available at no charge on GAO’s Web 

site at http://www.gao.gov. We will also make copies available to others on request. 

If you or your staff have any questions about this report, please contact me at (202) 

512-7119 or steinwalda@gao.gov. Contact points for our Offices of Congressional 

Relations and Public Affairs may be found on the last page of this report. GAO staff

who made major contributions to this report are listed in enclosure II.

A. Bruce Steinwald 

Director, Health Care 

Enclosures – 2 
Enclosure I Enclosure I 

15 GAO-06-17R Comments on Proposed 2006 SCOD Rates 

Comments from the Department of Health and Human Services 
Enclosure I Enclosure I

16 GAO-06-17R Comments on Proposed 2006 SCOD Rates
Enclosure I Enclosure I

17 GAO-06-17R Comments on Proposed 2006 SCOD Rates
Enclosure I Enclosure I

18 GAO-06-17R Comments on Proposed 2006 SCOD Rates
Enclosure II Enclosure II 

19 GAO-06-17R Comments on Proposed 2006 SCOD Rates 

GAO Contact and Staff Acknowledgments 

GAO Contact

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

Acknowledgments

Jon Ratner, Assistant Director; Hannah Fein; Dae Park; Phyllis Thorburn; Thomas 

Walke; and Craig Winslow contributed to this report. 

(290487) 
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