Medicare: Information Needed to Assess Adequacy of Rate-Setting Methodology for Payments for Hospital Outpatient Services
Published: 2004-09-17T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: 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.
section_title: What GAO Found
paragraphs: 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.

section_title: Letter
paragraphs: 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.  During the development of OPPS, the anticipated use of 1996 data  prompted concerns that the costs of new technology items, such as drugs,  biologicals, 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), 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  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.  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), 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 devices were incorporated  into OPPS.  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.
To address these objectives, we analyzed 2003 and 2004 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.  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.  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  August 2004 in accordance with generally accepted government auditing  standards.
subsections: section_title: Background
paragraphs: 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.
subsections: section_title: CMS Methodology for Determining APC Payment Rates
paragraphs: On outpatient claims, hospitals identify the primary services they provided  using a Healthcare Common Procedure Coding System (HCPCS) 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  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-to- charge 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.
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  new APC assignments and the charges from the latest available outpatient  hospital claims to recalibrate the relative weights, and therefore the  payment rates.
section_title: Expiration of Drug and Device Pass-Through Eligibility
paragraphs: 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.   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  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.
section_title: Payment Rates Were Generally Lower for Separately Paid Drugs, but Cannot Be Evaluated for Packaged Drugs and Devices
paragraphs: 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.
subsections: section_title: Payment Rates Generally Decreased For Separately Paid, Former Pass-Through Drugs
paragraphs: 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.  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  (19 percent), and generic (10 percent).  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.
section_title: Packaged Drugs and Devices Do Not Have Distinct Payment Rates
paragraphs: 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  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.
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.  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  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 pass- through device category because CMS did not identify the APC or APCs  into which the costs of the devices in this device category were packaged.
section_title: No Type of Hospital Provided a Disproportionate Number of Services Associated with Certain Drugs and Devices
paragraphs: 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.
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.   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.
section_title: Payment Rates May Not Uniformly Reflect Hospitals’ Costs
paragraphs: 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  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.
subsections: section_title: CMS May Not Be Using a Representative Sample of Claims to Set Payment Rates
paragraphs: 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.  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.  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  available do not allow for the comparison of single-service claims and  multiple-service claims to determine whether excluding many multiple- service 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.
section_title: Rate-Setting Methodology Does Not Account for Variation in Hospital Charge-Setting Practices
paragraphs: 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  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.
section_title: Conclusions
paragraphs: 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-to- charge ratio may not result in an accurate calculation.
section_title: Recommendations for Executive Action
paragraphs: 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.
section_title: Agency and External Reviewer Comments and Our Evaluation
paragraphs: 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).
subsections: section_title: CMS Comments and Our Evaluation
paragraphs: 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,  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 rate- setting 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.
section_title: Industry Comments and Our Evaluation
paragraphs: 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 pass- through 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 rate- setting methodology does not account for variation in hospital charge- setting 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  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.
section_title: Scope and Methodology
paragraphs: 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  2003 OPPS payment rates.  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.   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  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.
section_title: Summary of Hospital Charge-Setting Methodologies
paragraphs: 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).
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.
section_title: Comments from the Centers for Medicare & Medicaid Services
section_title: GAO Contact and Staff Acknowledgments
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section_title: Acknowledgments
paragraphs: Beth Cameron Feldpush, Joanna L. Hiatt, Maria Martino, and Paul M.  Thomas made major contributions to this report.
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