Most individuals diagnosed with ESRD are eligible to receive Medicare benefits under both Medicare Parts A and B. Medicare covers over 80 percent of all individuals with the disease. ESRD treatment options include kidney transplantation and maintenance dialysis. The latter removes substances that would otherwise be filtered through the kidney from the individual's blood. Kidney transplants are not a practical option on a wide scale, as not all patients are candidates for transplant and suitable donated organs are scarce. In contrast, dialysis is the treatment used by most ESRD patients. Dialysis can be administered through two methods: hemodialysis and peritoneal dialysis. During hemodialysis, a machine pumps blood through an artificial kidney, called a hemodialyzer, and returns the cleansed blood to the body. Hemodialysis, the most prevalent treatment method, is generally administered at freestanding facilities that provide dialysis services. The conventional regimen includes hemodialysis three times a week. Peritoneal dialysis--which is generally done in the home--utilizes the peritoneal membrane, which surrounds the patient's abdomen, as a natural blood filter. Patients remove wastes and excess fluids from their abdomen manually throughout the day, or a machine automates the process while they sleep at night. This procedure eliminates the need for the blood to leave the body of the patient and filter through a machine. The use of peritoneal dialysis has declined as a treatment modality over the last decade. One of the complications of ESRD is anemia, a condition in which an insufficient number of red blood cells is available to carry oxygen throughout the body. In ESRD patients, this condition is treated by maintaining at an optimal level the percentage of red blood cells relative to all cells in whole blood (by volume). This measure is known as the hematocrit (Hct) level. The Kidney Disease Outcomes Quality Initiative (KDOQI), established by the National Kidney Foundation, has set the minimum target for ESRD patients' Hct levels at 33 percent and has found insufficient evidence to recommend routinely maintaining Hct levels at 39 percent or greater. ESRD patients receive Epogen to keep their Hct above a minimum level. The Food and Drug Administration (FDA) labeled Epogen for use encompassing a somewhat lower Hct target level ranging from 30 to 36 percent. Recent clinical studies cited by KDOQI indicate that there may be increased patient mortality and morbidity if Hct levels are much higher than 39 percent. Epogen is typically administered to Medicare ESRD patients intravenously. Epogen can also be administered subcutaneously, that is, through an injection under the skin. The subcutaneous method requires less epoetin, but experts note that, because some pain is associated with this method, patients generally prefer intravenous delivery. Medicare's composite rate is designed to cover the cost of services associated with a single dialysis treatment, including nursing and other clinical services, social services, supplies, equipment, and certain laboratory tests and drugs. Under the composite rate, facilities receive a fixed payment, regardless of their actual costs to deliver these services. In 2006, the composite base rate is about $130 for freestanding dialysis facilities. Medicare pays separately for certain drugs and laboratory tests that have become routine treatments since 1983. These drugs include, but are not limited to, epoetin (brand name, Epogen), injectable vitamin D, and injectable iron. Epogen is generally administered to most patients at every dialysis treatment, whereas the other drugs, although routinely provided, are not administered as frequently. Table 1 highlights three separately billable prescription drugs provided routinely to dialysis patients. As table 1 shows, three drugs--iron sucrose, paricalcitol, and epoetin alfa--account for about 87 percent of Medicare spending on separately billable ESRD drugs. Although each of these three drugs is a "sole-source" product--that is, produced by a single manufacturer--two of the three have pharmaceutical alternatives available, whereas the third, epoetin, has no available alternatives in the ESRD market. In recent years, Medicare's method of paying for separately billable ESRD drugs has changed several times. Beginning in 1998, Medicare law required that payment for drugs covered under Part B equal 95 percent of the drug's average wholesale price (AWP). Despite its name, however, AWP was neither an average price nor the price wholesalers charged. It was a price that manufacturers derived using their own criteria; there were no requirements or conventions that AWP reflect the price of an actual sale of drugs by a manufacturer. An analysis we conducted in 2001 on Part B drug prices found that Medicare's AWP-based payments often far exceeded market prices that were widely available to health care providers. The MMA mandated that in 2005 Medicare pay for separately billable ESRD drugs based on their acquisition costs, as determined by the HHS Office of the Inspector General (OIG). Since acquisition costs were not defined in the MMA, the OIG determined a drug's average acquisition cost based on a survey of prices providers paid for the top 10 ESRD drugs, ranked by Medicare expenditures. For 2005, Medicare paid the OIG- determined average acquisition cost for the top 10 ESRD drugs. For 2006, the MMA gave the HHS Secretary discretion to alter the basis of payment for separately billable ESRD drugs. Under this authority, CMS determined that Medicare would pay for the separately billable ESRD drugs using the method required by the MMA to pay physicians for these drugs--that is, 106 percent of the drug's ASP. CMS instructs pharmaceutical manufacturers to report data to CMS on the ASP for each Part B drug sold by the manufacturer, within 30 days after the end of the quarter. For drugs sold at different strengths and package sizes, manufacturers are required to report price and volume data for each product, after accounting for price concessions. CMS then aggregates the manufacturer-reported ASPs to calculate a national ASP for each drug category. ASP rates are calculated and posted every quarter. The rates reflect the sales price on average from 6 months earlier. Since 2003, several legislative and regulatory changes have been implemented affecting Medicare's composite rate for routine ESRD services and payment rates for separately billable ESRD drugs. The changes have increased the composite rate and reduced the subsidy facilities obtained from generous Medicare payments for the separately billable drugs under pre-MMA payment rates. Nevertheless, as long as facilities receive a separate payment for each administration of each drug and the payment exceeds the cost of acquiring the drug, an incentive remains to use more of these drugs than necessary. For Epogen, the most frequently used drug, several months of data indicate that the per-patient use of this drug continues to rise, although at a slower rate than under pre- MMA payment rates. The MMA initiated new Medicare payment provisions addressing the composite rate and payment for separately billable drugs. Prior to the MMA's payment changes, facilities relied on payments for separately billable drugs to subsidize the cost of providing dialysis services covered under the composite rate. In a 2004 report, we found that, in 2001, Medicare's payment for the composite rate was 11 percent lower on average than facilities' average costs to provide the items and services included in the composite rate, whereas Medicare's payment for separately billable drugs was 16 percent higher than facilities' average costs of acquiring these drugs. We concluded that this payment disparity created an incentive for facilities to overuse separately billable drugs, as payments for them compensated for losses on items and services included in the composite rate. Together with the MMA provisions, more recent legislative and regulatory changes have reduced the disparity between Medicare's payments and facilities' average costs for both composite rate services and separately billable drugs. Essentially, these changes lowered payments for separately billable drugs from their pre-MMA amounts, and raised payments for the composite rate. The base composite rate was increased by 1.6 percent in 2005 and 2006 and the composite rate total was further increased through a "drug add-on" payment, which shifted some of the payments for separately billable drugs to the composite rate. In 2005, the add-on equaled 8.7 percent of the updated composite rate. In 2006, the 8.7 percent was replaced with a drug add-on payment of 14.5 percent of the 2006 updated composite rate. (See table 2.) The most significant changes to the ESRD payment system are the changes in payment rates for separately billable drugs. In 2005, Medicare's payment rates based on average acquisition costs were lower than its previous payment rates based on 95 percent of AWP. For example, from 2004 to 2005, the per-unit rate for iron dextran decreased from $17.91 to $10.94 and the per-unit rate for paricalcitol decreased from $5.33 to $4.00. (See table 3.) Since 2006, when the payment method for separately billable drugs changed to ASP + 6 percent, Medicare's payment rates have varied from quarter to quarter but have remained relatively consistent with the lower 2005 payments based on average acquisition costs. Since the implementation of these changes, Medicare spending for individual separately billable ESRD drugs has decreased to varying degrees. Beginning in 2005, when Medicare's payment method for these drugs changed from AWP to average acquisition cost, Medicare expenditures for several separately billable drugs decreased 11.8 percent from 2004. (See table 4.) Specifically, the average payments for iron sucrose and paricalcitol decreased by almost 35 percent and 25 percent, respectively. Similarly, payment for Epogen was lower than it had been for the previous decade, when it was set statutorily at $10 per unit, but the reduction--3.2 percent--was significantly less compared with the other drugs. Because payments to facilities for separately billable drugs are closer to the cost of acquiring these drugs and because composite rate payments have increased, the degree of cross-subsidization to support services provided under the composite rate has diminished, but the incentive to overuse these drugs has not been eliminated. To the extent that facilities can obtain the drugs for less than Medicare's payment rates and that the volume of drugs billed for separately increases facilities' revenue, an incentive remains for facilities to overuse these drugs to maximize revenues. to increase the validity of our he year We restricted the data to the first half of t comparison of previous years to 2006, for which we have only partial data. ote: Data are per ESRD patient with at least one Epogen claim in the first 6 months. We restricted N the utilization data to the first half of the year to make our comparisons consistent with 2006 data, which we only have for the first 6 months of the year. In addition to payment changes, CMS has sought over time to limit expenditures for Epogen by issuing policies that link payment to utilization. That is, Medicare reduces payments when a patient's Hct level reaches a certain percentage. Since 1997, CMS has created three different monitoring policies to encourage the efficient use of Epogen for ESRD patients. Each of these policies has been closely aligned with the clinical guidelines for Hct levels endorsed by the National Kidney Foundation. In 1997, the first policy denied payment when a patient's 3-month rolling average Hct level exceeded 36.5 percent. In 1998, CMS revised the policy so that the maximum level for the 3-month rolling average Hct was 37.5 percent; if a patient exceeded that level, payments were not denied as long as the Epogen dose was reduced 20 percent. In July 2004, CMS issued a proposal for a new monitoring policy. After consultation with the dialysis community, the final policy took effect on April 1, 2006. Under this policy, when a patient's Hct level is above 39.0 percent, the facility must reduce the Epogen dosage by 25 percent of the preceding month's administered amount.43 44 Whether or not the facility reduces the dosage, Medicare pays the facility as though the reduction has occurred--in effect, not rewarding the facility for overutilization. In broad terms, Medicare's policy is to set payment rates that are adequate to ensure beneficiary access to services but do not exceed the costs efficient providers incur to furnish needed care. In prior work on Medicare payment for Part B drugs, which include separately billable ESRD drugs, we noted that the ASP method was practical for setting payment rates compared with Medicare's previous methods to pay for these drugs, but we remained concerned about the appropriateness of the rates set under ASP. The practical aspects of ASP are several: it is based on actual transactions and is a better proxy for providers' acquisition costs than Medicare's previous methods to pay for these drugs; ASP is the most recent publicly available price information, as it is updated quarterly, and is therefore timely for rate-setting purposes; and price data from manufacturers are administratively easier for CMS to collect than obtaining such data from health care providers. Medicare has a process under which facilities can appeal the denial of a claim by showing that it is medically necessary. 42 U.S.C. SS 1395ff (2000). Effective October 2006, CMS revised the monitoring policy to, among other things, clarify its policy for reporting dosage reductions. setting the payment rate for Medicare Part B drugs at 6 percent above AS further complicating efforts to determine the appropriateness of the rate. The ASP payment method is of particular concern with respect to Epogen because it is the only product available in the ESRD market for anemia management. The ASP method relies on market forces to achieve a favorable payment rate for Medicare--that is, one that is sufficient to maintain beneficiary access but not overly generous for providers and therefore wasteful for taxpayers. In principle, under ASP, when two or more clinically similar products exist in a market, market forces could serve to bring prices down, as each manufacturer competes for its own product's market share. In contrast, when a product is available through only one manufacturer, Medicare's rate lacks the moderating influence of competition. For this reason, Medicare's ASP method may not be appropriate for Epogen, which is the product of a single manufacturer has no competitor products in the ESRD market. The lack of price competition may be financially insignificant for noncompetitive products that are rarely used, but for Epogen, which is pervasively and frequently used, the lack of price competition could be having a considerable effect on Medicare spending. Since the introduction of Epogen in the ESRD anemia management market, it has been difficult for competitor products to enter this market. Amgen, Epogen's manufacturer, has held seven patents on Epogen, the first of which was granted in 1987 and the last of which expires in 2015; Amgen has obtained injunctions against pharmaceutical firms seeking to market their anemia management drugs in the United States. However, competitor products may enter the U.S. market in the near future. There are three potential sources of future competition: a drug that currently exists, drugs that are likely to enter the market soon, and products that are under development. Aranesp is a drug that Amgen manufactures and markets to hospitals and physicians to treat anemia in patients with cancer and chronic kidney disease but generally does not market to ESRD facilities. CERA is a drug that the manufacturer--F. Hoffmann LaRoche-- hopes to introduce in the United States sometime in 2007. Certain products currently in development, which are several years away from entering the market, could have a distinct advantage over injectable products, as they are expected to be long-lasting oral therapies. The composite rate for routine dialysis-related services was the first of Medicare's several payment systems that, in broad terms, sets a fixed, prospective rate for a set of clinically related services. Consistent with payment policy, the Congress has required CMS to develop a system tha would no longer pay for each injectable ESRD drug under a separate rat but would bundle payment for these drugs together with other ESRD services under a single rate. A bundled rate would have advantages for achieving efficiency and greater clinical flexibility. CMS's design of a bundled rate is under way but behind schedule, making the implementation of a fully bundled payment system, based on this design, at least several years away. Any payment system changes based on report or demonstration would require legislation. Medicare's approach to paying for most services provided by facilities is to pay for a group--or bundle--of services using a prospectively set rat e. For example, under prospective payment systems, Medicare makes bundled payments for services provided by acute care hospitals, skilled nursing facilities, home health agencies, and inpatient rehabilitation facilities. In creating one payment bundle for a group of associated items and services provided during an episode of care, Medicare encourages providers to operate efficiently, as providers retain the difference if Medicare's payment exceeds the costs they incur to provide the services. Medicare's composite rate for routine dialysis-related services was introduced in 19 and was the program's first bundled rate. MedPAC), and CMS have recommended expanding the bundled payment In recent years, we, the Medicare Payment Advisory Commission ( for ESRD services to include not only the services paid under the composite rate but also the drugs that facilities currently bill for separately. Experts contend that a bundled payment for dialysis-related services would have two principal advantages. First, it would encourage facilities to provide services efficiently; in particular, under a fixed, bundled rate for a defined episode of care, facilities would no longer an incentive to provide more ESRD drugs than clinically necessary. Second, bundled payments would afford clinicians more flexibility in drug or decision making because incentives to prescribe a particular treatment are reduced. For example, certain clinical alternatives are, according to some ESRD experts, advantageous to patients and could result in the use of less Epogen, but these alternatives are not encouraged under the current payment system. Studies have shown that daily hemodialysis--which some experts contend is clinically preferable--reduced the need for Epogen in some ESRD patients with anemia. However, Medicare coverage is limited to three dialysis treatments a week. Under a bundled payment, facilities would have the flexibility to increase the number of weekly dialysis treatments and reduce their use of Epogen. Studies have also shown that patients who receive subcutaneous instead of intravenous injections of epoetin and patients undergoing peritoneal dialysis instead of hemodialysis need less epoetin to manage their anemia. Under t current payment system, which pays facilities for epoetin on a per administration basis, facilities have an incentive to select the epoe delivery method and the dialysis modality that maximize their Metin revenue. Under a bundled payment, facilities would have less incentive tochoose the costlier intravenous over subcutaneous injections of epoetin o r the costlier hemodialysis over peritoneal dialysis. Facility representatives, ESRD experts, and other interested parties w spoke with generally supported a bundled payment for dialysis-related items and services while underscoring the importance of certain elem as part of the bundled payment system. First, facility representatives noted that bundled payments called for a case-mix adjuster--that is, a mechanism to account for the differences in the mix of more expensive and less expensive patients across facilities. Without accounting for t differences, facilities that treated a disproportionate share of costly patients would be financially disadvantaged. Second, some facility representatives noted that an automatic paym update would be needed to adjust the bundled rate for inflation, consisten with Medicare's other bundled payment systems that are updated automatically on an annual basis. They pointed out that the current ESRD t composite rate is Medicare's only payment bundle that does not receive a automatic update. Third, ESRD experts we spoke with noted that, under bundling, the incentive to overuse services is blunted, but the incentive to underu se services is present. For example, facilities could choose to provide too little Epogen to patients with anemia because they would save money providing less of this costly drug. These individuals commented that CMS's monitoring policy, which currently focuses on overutilization of Epogen, would need to refocus its attention on underutiliza under a bundled payment system ESRD patients received appropriate levels of Epogen and other dialysis-related drugs and services. The MMA mandated a two-pronged approach for CMS to study the creation of a bundled payment method. It required CMS to submi to the Congress on a bundled payment system design in October 2005 an start a 3-year bundling demonstration in January 2006. The legislation he linked the two requirements by directing CMS to base the design of t bundling demonstration on the content of the required CMS to obtain input on the demonstration's design and implementation from an advisory panel that included industry and government experts. The report had not been issued nor had the demonstration been launched as of November 2006. Any payment s changes based on CMS's report or demonstration would require legislation. mandated report. It also The report and demonstration efforts, led by two different organizational units in CMS, face similar design considerations. Both must define the ESRD services to be included in a payment bundle, design a case-mix adjustment model to account for differences in patients' use of resources, and develop a payment policy for exceptional cases, known as an outlier policy. However, despite similar goals, each unit has a different focus. Essentially, the unit responsible for the report is designing a bundled payment system that is intended to be implemented programwide and expeditiously, following congressional approval. In contrast, the unit responsible for the demonstration is designing a bundled payment sy that is intended to be implemented on a limited and self-selective basis that is, through facilities' voluntary participation in the demonstration. The time frame for implementing a bundled payment system based on CMS's report is uncertain. Officials could not tell us when the report would be available. Furthermore, additional time is needed for the Congress to review the report and possibly pass legislation based on th report. CMS officials predict that it would take a minimum of 18 fully implement the system, once legislation had been enacted. The start of the bundled payment demonstration is similarly subject uncertain chain of events. Specifically, under MMA, CMS cannot launch its demonstration before considering the information in its mandated report. The rationale for Medicare to continue paying for Epogen and other E drugs outside of a payment bundle has diminished over time. Composite rate updates and add-ons, coupled with the overhaul of payment for P drugs, have moved Medicare toward paying more appropriately for ESRD services. Nevertheless, under the ASP payment method--which pays for separately billable ESRD drugs on a per administration basis--facilities continue to have an incentive to use these drugs more than may be necessary. Paying for Epogen under ASP presents an additional dilemm as a single-source drug in a market with no competitor products, Epo n is not subject to the moderating effects that competition can have o price. In our view, Medicare could realize greater system efficiency if a services, including drugs, were bundled under a single payment. A bundled payment--suitably adjusted for differences across facilities in their mix of patients--would encourage facilities to use drugs more prudently, as they would have no financial incentive to use more than necessary and could retain the difference between Medicare's payment and their costs. At the same time, because treatment choices would be payment neutral, clinicians would have more flexibility to try different treatment combinations of items and services paid for in the bundle. To account for facilities' increased or decreased costs over time, a reexamination of the bundled rate may be necessary periodically. In the case of Epogen, for example, if other competitor products entered the market in the future, the costs facilities would incur to treat anemia could decline. By adjusting the payment bundle accordingly, Medicare could realize the benefits of such cost reductions. CMS's time line is considerably protracted for issuing the mandate on a bundled ESRD payment system and conducting a demonst remains under development. The time needed to complete these steps makes the prospect of implementing such a system several years away. In light of the uncertain time frame for CMS's test of bundling and the potential for bundling to eliminate financial incentives to overuse separately billable drugs, the Congress should consider establishing a bundled payment system for all ESRD services as soon as possible. We invited representatives of drug manufacturers, large and small dialysis facility organizations, and a nephrologist specialty association to review and comment on the draft report. The groups represented were Amgen Inc. (Amgen), F. Hoffmann-La Roche Ltd. (Roche), the Kidney Care Council (KCC), the National Renal Administrators Association (NRAA), and the Renal Physicians Association (RPA). Several of the industry groups noted that the report was well written, thorough, and covered many of the issues affecting dialysis providers. The bulk of the groups' comments focused on three general issues central to the message of our report: the increase in utilization of Epogen over time, the current ASP- based payment system for ESRD drugs, and the implementation of a fully bundled ESRD payment system. First, Amgen, KCC, Roche, and NRAA noted that the report did not ful ly explain why utilization of Epogen has grown over time or why the gro wth rate has slowed in recent years. Amgen stated that the draft report did not sufficiently cover the goal of Epogen therapy--which is to increase patient Hct levels--and its link to improved quality of life for dialysis patients. KCC noted that while the average Epogen dose has increased over time, patient outcomes--as measured by average Hct levels--have also improved. KCC further contended that beca remained relatively flat in recent years, providers are not responding to the incentive to overuse ESRD drugs. Roche maintained that the slow growth in Epogen use over the past few years is attributable to more patients' having achieved Hct levels within the target range. NRAA addedthat the slower growth of Epogen use is positive because it demonstrates that providers use less Epogen as more patients reach the target Hct range. In our report, we discuss the utilization of Epogen rather than the clinica outcomes associated with that utilization. In response to the groups' comments, we have added information that describes the benefits of Epogen therapy as well as data on patient Hct levels prior to the MMA payment changes. Although we do not take a position on whether the drug is overutilized at the levels we report, we stand by our contention that an inherent incentive to maximize revenues exists when items are paid for on a cost-plus (e.g., ASP+6 percent), fee-for-service basis. It is because of the inherent nature of this incentive that we recommend combining payment for ESRD drugs with all dialysis services under a single bundled rate. l Second, all of the groups commented on our discussion in the report of the current ASP-based payment method for separately billable ESRD drugs, with some groups expressing concerns about an abrupt movement to a fully bundled rate. Amgen noted that the ASP method is relatively new and that it is too early to decide whether to move to a fully bundled rate. In addition, Amgen was concerned with our characterization of ASP payment issues associated with Epogen and stated that the entry of a new anemia management product may not necessarily result in reduced prices. Two of the organizations noted that, prior to moving to a bundled rate, a transitional system--one that encourages price competition for anemia management drugs--may be desirable. Roche stated that continuing to use the ASP-based payment system for Epogen could have negative downstream effects on a fully bundled ESRD payment system, as any price increases prior to bundling would be captured in the dollar amounts allocated for anemia management drugs included in the bundle. Similarly, KCC stated that an alternative payment system should be explored prior to bundling. KCC also stated that, as long as there is no viable clinical alternative to Epogen, bundling by itself would not provide for clinical flexibility, nor would bundling alone ensure drug price stability. KCC suggested that a transitional system could involve paying for drugs at ASP and transferring the rate's current 6 percent add-on to the composite rate. In general, both RPA and NRAA viewed the ASP-based payment method for ESRD drugs favorably. RPA specifically referred to the recent legislative and regulatory actions, including the move to an ASP-based rate, as "responsible," because payments for separately billable drugs were lowered while the composite rate was increased. Our dis separately billable drugs in general and on Epogen in particular because of its market domination and the high Medicare expenditures associated withcussion of the ASP-based payment method focuses on payment for it. We agree that the introduction of a competitor product may not res in immediate price reductions, but note that, in principle, competition tends to lower prices over time. Although we acknowledge that there m be a better way to pay for separately billable drugs than ASP+6 percent, our focus is on the need to mitigate the incentives that can undermine the efficient use of resources in ESRD care. Any transitional system that allows separate billing for individual drugs perpetuates the incentive to maximize revenues through utilization of these drugs. We agree that bundling by itself cannot solve problems resulting from the lack of pri competition. However, as noted in our draft report, if price competition w treatment costs for providers and--after adjustments to the bundle for these lower costs--could result in savings for Medicare. ere introduced under a bundled payment system, it could result in lower Finally, representatives from four of the groups expressed concerns about implementation challenges associated with a payment bundle. Consistent with CMS's position and the position of experts cited in our draft report, Amgen and KCC emphasized the importance of appropriate case-mix adjustment in a bundled payment system. KCC underscored the considerable variation in patients' need for Epogen and the role of the case-mix adjuster to ensure adequate compensation for providers treating patients needing unusually high levels of the drug. RPA, NRAA, and KCC were concerned that bundling could limit innovation in the ESRD or that physicians would be reluctant to use any new ESRD drugs that facilities would find to costly to cover within the payment bundle. Consistent with this concern, NRAA noted that the payment bund methodology should have a mechanism to ensure the appropriate incorporation of new technologies and treatment protocols. We agree that an appropriate case-mix adjuster is important to a bundled payment system and noted in the draft report that adjusting for diffe in patients' needs was a key point made by interested parties we contacted. We acknowledge that if the payment bundle does not accou for patient differences, facilities that treat a disproportionate share of costly patients would be financially disadvantaged. We note that CMS has done extensive research on case-mix adjustment in a fully bundled ESRD these payment system and believe that any new system will benefit from efforts. We also agree that a new payment bundle should be periodicallyupdated to reflect the costs of current technologies and treatment protocols. Specific details on the contents of a bun and evaluation over time were beyond the scope of this report. dle, its implementation, As we agreed with your office, unless you publicly announce the contents of this report earlier, we plan no further distribution of it until 30 days from the date of this letter. At that time, we will send copies of this rep ort to the appropriate congressional committees and other interested parties. We will also make copies available to others upon request. This report wi be available at no charge on GAO's Web site at http://www.gao.gov. If you or your staff have questions about this report, please contact me at (202) 512-7101 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 key contributions to this report are listed in appendix II. A. Bruce Steinwald (202) 512-7101 or steinwalda@gao.gov. Phyllis Thorburn, Assistant Director; Jessica Farb; Hannah Fein; Zachary Gaumer; and Shivani Sharma made key contributions to this report.

Summary:
Medicare covers dialysis--a process that removes excess fluids and toxins from the bloodstream--for most individuals with end-stage renal disease (ESRD), a condition of permanent kidney failure. The Centers for Medicare & Medicaid Services (CMS) pays for certain dialysis services under a type of bundled rate, called a composite rate, and, for certain dialysis-related drugs, pays a separate rate per dose each time the drug is administered. These drugs are referred to as "separately billable" and are paid at 6 percent above manufacturers' average sales price (ASP). Recently, the Congress required CMS to explore the creation of a bundled payment for all ESRD services, including separately billable drugs. GAO was asked to examine (1) recent changes in payments for ESRD services, (2) the ASP payment method of setting rates for separately billable ESRD drugs, and (3) CMS efforts to develop a bundled payment method that includes all ESRD drugs. GAO obtained information for this study from CMS, the U.S. Renal Data System, ESRD experts, and previously issued GAO reports. The effect of several legislative and regulatory changes since 2003 has been to raise the composite rate while reducing Medicare's pre-2005 generous payments for separately billable ESRD drugs. In 2005, when the first legislative change was implemented, Medicare expenditures for certain separately billable drugs dropped 11.8 percent. In 2006, Medicare regulation changed the payment for these drugs to a method based on ASP. Since then, Medicare's payment rates have varied from quarter to quarter but have remained relatively consistent with the lower 2005 payment rates. Medicare's cost containment efforts have targeted the most expensive of the separately billable drugs--Epogen--for which program spending totaled $2 billion in 2005. Epogen is used to treat anemia in ESRD patients; most patients receive this drug at nearly every dialysis session. Recent data indicate that Epogen use per patient continues to rise, although more slowly than in previous years. Several unknowns about the composition of ASP and the lack of empirical evidence for the percentage level added to ASP make it difficult for CMS to determine whether the ASP-based payment rates are no greater than necessary to achieve appropriate beneficiary access. Paying for Epogen under the ASP method is of particular concern. The ASP method relies on market forces to moderate manufacturers' prices; but Epogen is the product of a single manufacturer and has no competitor products in the ESRD market. Without competition, the power of market forces to moderate price is absent. For rarely used products, the lack of price competition may be financially insignificant, but for Epogen, which is pervasively and frequently used, the lack of price competition could be having a considerable effect on Medicare spending. In 2003, the Congress required CMS to issue a report and conduct a demonstration of a system that would bundle payment for ESRD services, including drugs that are currently billed separately, under a single rate. The bundled payment approach, used to pay for most Medicare services, encourages providers to operate efficiently, as they retain the difference if Medicare's payment exceeds the costs they incur to provide the services. GAO and others have found that a bundled rate for all ESRD services would have advantages for achieving efficiency and clinical flexibility in treating ESRD patients. CMS's demonstration testing the feasibility of a bundled rate, mandated to start in January 2006, is delayed, as is the completion of the agency's mandated report to the Congress on bundling. The report was due in October 2005; as of November 2006, CMS officials could not tell us when the report would be available.