Under the IPPS, hospitals are not paid separately for each item or service they provide. Rather, payment is based on the DRG to which the entire inpatient stay is assigned. Each of the 538 DRGs has a classification, that is, an assigned combination of any of the approximately 17,000 diagnoses and procedures codes. When codes for these diagnoses and/or procedures appear together on a claim, the inpatient stay is assigned to the appropriate DRG and paid accordingly. In addition, CMS determines if the inpatient stay is eligible for an outlier payment beyond the DRG payment. Hospitals can receive outlier payments for individual inpatient stays determined to be extremely costly if a hospital can demonstrate that the estimated cost of an individual inpatient stay exceeds a cost threshold established by CMS. Medicare law requires CMS to revise the DRG classifications and payment weights at least annually to reflect changes in treatment patterns, new medical services and technologies, and other factors that may change the relative costliness of an inpatient stay. To accomplish this, CMS assembles a MEDPAR file from inpatient claims for a fiscal year, so that the file contains one record for each inpatient stay provided during that year. A MEDPAR record includes the admission and discharge dates, patient and hospital identifiers, and codes that identify the diagnosis and the procedures delivered during the inpatient stay. The record also contains the hospital's total charge for the inpatient stay. The total charge represents the charges for all services--including any new technology, drugs, or supplies--provided during the inpatient stay. The total payment to the hospital is also included in the MEDPAR record. MEDPAR records do not indicate the hospital's actual cost for the inpatient stay or the cost of individual procedures, which are not recorded on claims by hospitals. CMS uses data from the MEDPAR file to revise the DRGs for the coming fiscal year. It revises the DRGs in a two-step process: reclassification of DRGs and calculation of DRG payment weights. First, CMS incorporates new codes into the IPPS that represent new diagnoses or procedures by assigning them to the same DRGs as existing codes for clinically similar diagnoses or procedures. Using data from the MEDPAR file, CMS may reclassify the DRG assignment of inpatient stays with a particular procedure or diagnosis code if it determines the inpatient stays are more similar in their clinical characteristics and costliness to a DRG other than the DRG to which those stays were previously assigned. CMS will create a new DRG if it determines that the inpatient stays involving newly identified diagnoses and procedures cannot be described by any of the existing DRGs. The classification of most DRGs does not change from year to year. The second step in revising the DRGs involves calculating weights across all DRGs, so that the DRGs reflect the expected relative differences in costliness of inpatient stays for the upcoming fiscal year. Prior to fiscal year 2007, CMS annually derived each DRG's weight by dividing the average charge per inpatient stay for that DRG by the average charge per inpatient stay across all DRGs for a fiscal year. Effective fiscal year 2007, CMS uses charge data from the MEDPAR file and hospitals' cost-to-charge ratios from Medicare cost reports to estimate the costs per inpatient stay. CMS then uses these average estimated costs to measure the relative costliness of inpatient stays that will be assigned to each DRG. In reclassifying and weighting DRGs, CMS generally requires that the data meet three criteria: (1) the data must be representative of the Medicare population; (2) the data must be timely--that is, they should be the most recent data available; and (3) the data must be complete--meaning that CMS needs total charges or other measure of costliness for all services provided during an inpatient stay. Charge data collected at the inpatient- stay level allow CMS to appropriately measure relative costliness across the DRGs. The DRG classifications and payment weights for any given fiscal year are based on data from the MEDPAR file for inpatient services provided 2 fiscal years prior, and therefore, do not reflect the cost of the most recently used technologies. For example, during the summer of 2006, when CMS was finalizing the DRGs for fiscal year 2007, the most recent data pertained to inpatient services provided through the end of fiscal year 2005, and did not reflect the cost of technologies first adopted by hospitals in fiscal year 2006. The time lag in the data that are used to set DRG classifications and weights is primarily due to two factors in combination: the time it takes to annually finalize the DRGs, and the time it takes for CMS to process each inpatient claim into a MEDPAR record. First, Medicare law requires that DRG classifications and weights be revised annually and published in the Federal Register on or before the August 1 before each fiscal year. Fiscal years begin October 1 and end the following September 30. In order to obtain public input, CMS generally publishes its proposed DRGs for the coming fiscal year in the Federal Register each April and accepts comments for 60 days before publishing the final DRGs by August. The second factor that affects the incorporation of the cost of new technologies into the MEDPAR file involves the time it takes for CMS to process each inpatient claim into a MEDPAR record. Before a record for an inpatient stay can be added to the MEDPAR file, the hospital must submit the claim, a private contractor must process and pay the claim, and CMS must create a MEDPAR record using information on the claim. It takes about 6 months from the time of the inpatient stay to the time the MEDPAR record for that inpatient stay is created. In addition, the MEDPAR record may not be added to the MEDPAR file until as much as 3 months later, since the MEDPAR file is updated quarterly--in December, March, June, and September. This means that MEDPAR records are not available to CMS until 6 to 9 months after the inpatient stay has occurred. (See fig. 1.) Because DRG payments for a given fiscal year are based on claims for inpatient services provided 2 fiscal years prior, Medicare can provide hospitals with add-on payments, in addition to the DRG-based payments, for inpatient stays involving certain new technologies. CMS designates technologies for add-on payments if they meet specified criteria for being new, costly, and a substantial clinical improvement over existing technologies. CMS considers a technology new if no more than 2 to 3 years have passed between the date when the technology was first introduced on the market, as identified by CMS, and the payment year. At the end of this period, CMS assumes the costs for the technology to be fully reflected in the most recent MEDPAR file and supplemental add-on payments are no longer necessary. CMS considers a new technology costly if the average amount charged by hospitals for all inpatient stays involving the technology exceeds a charge threshold or a predetermined amount. CMS considers a new technology a substantial clinical improvement over existing technologies if the technology has one or more unique clinical advantages--for example, the technology diagnoses a medical condition in a patient population where that condition was previously undetectable. Every year, CMS accepts applications from technology manufacturers, hospitals, and other stakeholders, in which they present evidence that certain technologies meet the criteria for add-on payments in the coming fiscal year. When CMS publishes its final DRG classifications and weights, it summarizes each application, and explains why the particular technology was approved or rejected for add-on payments. For fiscal year 2007, CMS approved one new application and continued add-on payments for two technologies approved for fiscal year 2006. As a result, hospitals receive an add-on payment, in addition to a DRG payment, when they submit a claim to Medicare that includes the code for a procedure involving one of those three technologies. The amount of the add-on payment is determined on a claim-by-claim basis; the hospital receives up to half the estimated cost of the technology, depending on the amount by which the total cost of the inpatient stay is estimated by CMS to exceed the DRG-based payment. CMS has used external data for two purposes: to inform DRG reclassification and to evaluate new technology add-on payment applications. To inform DRG reclassification, CMS accepts the submission of external data that are intended to demonstrate that inpatient stays involving a new technology are costlier on average than the other inpatient stays in the same DRG. CMS uses data from the MEDPAR file to validate the external data submitted. Generally, CMS will not make a reclassification decision for a DRG involving a new technology if the technology is so new that it does not appear in the MEDPAR file. To evaluate new technology add-on payment applications, CMS has generally used external data in conjunction with data from the MEDPAR file to evaluate whether a new technology meets one of three eligibility criteria, specifically, the criterion related to cost. CMS officials told us they have used external data to inform the DRG reclassification process. External data are submitted by stakeholders as part of a request to reclassify--from one DRG to another--certain procedure codes involving particular new technologies. Although CMS will accept the submission of external data, it has used data from the MEDPAR file to validate the external data submitted. Specifically, when external data are submitted for a proposed DRG reclassification for a procedure or new technology, CMS's policy is to find the same or similar evidence in the MEDPAR file. CMS encourages stakeholders to submit their external data for DRG reclassification purposes by the December before the issuance of the proposed rule the following April. Although there is no formal application process to request a DRG reclassification, CMS explained its policy for accepting external data submissions in its July 30, 1999, notice of final rulemaking. It stated that external data submissions must be sufficiently detailed--include applicable hospital and beneficiary identifiers, procedure and diagnosis codes, admission and discharge dates, and total charges for each inpatient stay involving the codes--so that CMS can validate whether the same, or similar, inpatient stays appear in the MEDPAR file. CMS also requires that the external data submitted comprise a complete set, or representative sample, of cases involving the technology. CMS will not reclassify a procedure code from one DRG to another based on the external data submission alone. As a result, CMS generally will not make a DRG reclassification involving a technology that is so new it does not yet appear in the MEDPAR file. CMS has used external data to evaluate applications for new technology add-on payments to better recognize the cost of technologies that are clinically beneficial yet would not be fully reflected in the MEDPAR file. CMS designates technologies for add-on payments if they meet specified criteria for being new, costly, and a substantial clinical improvement over existing technologies. CMS's use of external data is limited to its evaluation of the cost criterion. CMS has generally used external data and data from the MEDPAR file to evaluate whether a new technology that is being considered for an add-on payment meets the criterion for being considered costly. As of fiscal year 2007, according to our review of CMS regulations and our interviews with CMS officials, CMS has received few applications for add- on payments--a total of 25, which is an average of about 5 per year since fiscal year 2002. All but two applications were submitted by device and drug manufacturers. When CMS receives an application for a new technology add-on payment, it first evaluates whether the technology meets the criterion of being new before it evaluates the technology under the cost and clinical improvement criteria. The majority of new technology add-on payment applications have been rejected because the technology failed to meet the newness criterion. For these applications, CMS did not have to review any information related to the cost and clinical improvement criteria, including external data related to the cost criterion. Of the 25 applications received, CMS evaluated 14 under the cost criterion. Of these 14 technologies, CMS approved 7 for new technology add-on payments. When CMS evaluates new technologies under the cost criterion, it uses external data in conjunction with data from the MEDPAR file to determine whether the technology meets the cost criterion. Table 1 illustrates three hypothetical scenarios in which CMS, during fiscal year 2007, could use external data in conjunction with data from the fiscal year 2006 MEDPAR file in determining if a new technology is eligible for add-on payments for fiscal year 2008 under the cost criterion. Data collected and used by other government agencies have limitations for CMS's use in setting DRG payments for inpatient stays involving new technologies. This is because, when setting DRG payments, CMS generally needs data that are representative of the Medicare population, timely, and complete in that the data include the total charge or other measure of costliness for all services provided during an inpatient stay, including new technologies. The data we identified from BLS, VA, DOD, and AHRQ were either not representative of the Medicare population, were no timelier than data from the MEDPAR file, or were not complete. BLS collects monthly selling prices for samples of products from three industries that may have data relevant to CMS because these data include price information for new technologies: medical instruments, pharmaceuticals, and biological products. These data, collected from manufacturers, are used to publish the Producer Price Index (PPI), which tracks the inflation of prices by producers of goods and services at the national level. Because BLS cannot obtain pricing for every medical instrument and pharmaceutical and biological product sold, it employs a sampling methodology to track prices. Using probability statistics, BLS selects a sample of products whose price changes over time will be representative of the price changes characteristic of the medical instrument and pharmaceutical and biological product industries. Generally, BLS selects a new sample of products per industry every 7-8 years. The monthly selling prices collected include prices for transactions between manufacturers and hospitals, wholesalers, group purchasing organizations, or other customers. BLS data have a number of limitations that would affect CMS's use in setting DRG payments. Because the selling prices reflect transactions between manufacturers and a variety of purchasers such as group purchasing organizations as well as hospitals, not all of these prices are directly relevant for setting DRG payments. To set payments, CMS needs data that reflect hospitals serving Medicare beneficiaries. In addition, since BLS relies on a sample of products from each industry, and the sample is generally updated on average every 7-8 years, it is unlikely that BLS will have price data for a new technology that CMS does not already have, or cannot obtain from a manufacturer. Finally, the BLS data lack information needed by CMS on the costliness of inpatient stays involving the technology relative to other inpatient stays; instead, they only include price data for the technology alone. Two types of VA data, price data from the federal supply schedule (FSS) and data on inpatient stays at VA hospitals, also have limitations that would affect CMS's use in setting DRG payments. VA collects data from drug and device manufacturers on the prices manufacturers charge their Most-Favored Customers (MFC). These data are used to negotiate prices on the FSS, which is a schedule of prices for products used by federal agencies. Prices on the FSS are awarded at equal to or better than the prices manufacturers charge their MFCs. Because all federal agencies and programs may access FSS price information on the Internet, CMS already has access to these prices. Similar to BLS data, FSS data are not complete for CMS's purposes because they lack information on the costliness of inpatient stays involving the technology relative to other inpatient stays. VA also collects data on inpatient stays at its medical centers. These data are complete for CMS's purposes in that they include all services provided during inpatient stays and their associated costs, including the cost of any new technologies. However, there are still limitations for CMS's use of these data in setting DRG payments. First, the costs of providing care at VA medical centers may not be representative of the costs of providing care at hospitals that provide care to Medicare beneficiaries. VA is a provider of services and, as such, VA has the authority to purchase new technologies at discounted rates through various federal purchasing options, such as the FSS. Medicare, on the other hand, is a payer--not a provider--of services and does not purchase drugs and devices for hospitals. Therefore, Medicare does not negotiate discounts on behalf of hospitals providing services to Medicare beneficiaries. Furthermore, VA inpatient stay data are no timelier than MEDPAR data for determining payments to hospitals. For example, VA's allocation of funding to its medical centers for fiscal year 2007 is based on data spanning fiscal years 2003 through 2005. Medicare used fiscal year 2005 data to develop fiscal year 2007 DRG payments. DOD data also have limitations for CMS's use in setting DRG payments. DOD health care delivery consists of two integrated systems: the direct care system delivered by DOD hospitals, known as Military Treatment Facilities (MTF), and the civilian system. The latter is coordinated by the TRICARE Management Activity (TMA), which contracts with managed care organizations to deliver care, including inpatient services. Data from the DOD direct care system would not meet CMS's criterion for completeness for two reasons. First, DOD collects overall cost data at the facility level rather than the inpatient-stay level. CMS needs charge or cost data at the inpatient stay level to set DRG payments. Second, while DOD uses cost and pricing data from a variety of sources when purchasing medical products, such as drugs and devices for its MTFs, these data alone are not appropriate for CMS's use in setting DRG payments because CMS needs information on the costliness of inpatient stays involving the technology relative to other inpatient stays. Data from the DOD civilian system also have limitations for CMS's use in setting DRG payments. TMA pays for inpatient stays using a DRG-based payment system that is modeled on the Medicare IPPS. Although TMA's data would be complete for CMS's purposes in that the data include total charges for all services provided during an inpatient stay, they would not meet CMS's criterion for representativeness. According to DOD, its population tends to be younger and healthier and, therefore, not comparable to the Medicare population. AHRQ collects claims data from nearly all nongovernmental acute care hospitals in 38 states and these data represent approximately 90 percent of inpatient stays in the United States. AHRQ partners with state organizations, which collect claims data directly from hospitals; these data are then submitted to AHRQ. According to AHRQ, these data, which are available to researchers through the Healthcare Cost and Utilization Project (HCUP) claims database, are representative of the Medicare population overall. The data from the HCUP database are also complete in that they include charge, diagnosis, and procedure information from Medicare as well as private payers. Although data from the HCUP database would meet CMS's criteria for being representative of the Medicare population and are complete, these data are less timely than data from the MEDPAR file. AHRQ data lag between 15-18 months, so, for example, if CMS were to use data from the HCUP database to set payments for fiscal year 2007, the latest available data from AHRQ would include inpatient services for calendar year 2004, while the latest available data from the MEDPAR file would include inpatient services from fiscal year 2005. Data from the MEDPAR file remain the primary data source for setting DRG payments because they include all charges from inpatient claims for inpatient services provided to all Medicare beneficiaries across all hospitals paid under the IPPS. CMS needs these data to determine payment for each DRG relative to other DRGs. In instances where data from the MEDPAR file have lacked charge information for certain stays involving new technologies, CMS has used external data to inform the DRG reclassification process and to evaluate new technology add-on payment applications. To set DRG payments, CMS needs data that meet criteria of being representative, timely, and complete. Although BLS, VA, DOD, and AHRQ collect data for their own purposes that could potentially be useful to CMS, these data are limited in their utility to set DRG payments because they do not always meet CMS's criteria. In commenting on a draft of this report, CMS stated that it agreed with our findings and reiterated its commitment to using external data when appropriate. (See app. I.) DOD said it had no comments on the draft of this report. (See app. II.) We received comments from VA via email. The department agreed with the facts as they pertain to VA. We also sent a draft of this report to DOL. DOL did not provide comments. Representatives from American Hospital Association (AHA), Association of American Medical Colleges (AAMC), and the Biotechnology Industry Organization (BIO) provided oral comments on a draft of this report. They said they agreed with our findings related to the use of external data by CMS. With regard to our finding that data from other government agencies have limitations for CMS's use in setting DRG payments, both AAMC and BIO said we should have discussed CMS's use of data from sources other than the federal government. As we discussed in the draft report, CMS has used external data from sources other than the federal government including manufacturer data to inform DRG reclassification and evaluate new technology add-on applications. AAMC said it was concerned that we only examined how CMS used the external data and did not conduct an evaluation of CMS's policy for using external data. However, as discussed in the draft report, an examination of CMS's policy for accepting external data was not within the scope of the report. In addition, CMS, AAMC and AHA offered technical comments on the draft of this report, which we incorporated as appropriate. We are sending a copy of this report to the Administrator of CMS and interested congressional committees. We will also provide copies to others on request. The report is available online at no charge on GAO's Web site at http://www.gao.gov. If you or your staff have any questions, please contact me at (202) 512-7114 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 appendix III. In addition to the contact above, Maria Martino, Assistant Director; Melanie Anne Egorin; Yorick F. Uzes; and Craig Winslow made key contributions to this report.

Summary:
Under Medicare, hospitals generally receive fixed payments for inpatient stays based on diagnosis-related groups (DRG), a system that classifies stays by patient diagnoses and procedures. The Centers for Medicare & Medicaid Services (CMS) annually uses its own data to reclassify DRGs. CMS also makes add-on payments for stays involving new technologies that meet three eligibility criteria. Stakeholders may submit data that are external to CMS as part of a DRG reclassification request or an add-on payment application. The Medicare Prescription Drug, Improvement, and Modernization Act of 2003 required GAO to examine whether CMS could improve its use of external data, including using data collected by other government agencies for DRG payments. As discussed with the committees of jurisdiction, GAO examined (1) to what extent CMS has used external data in determining payments for inpatient stays involving new technologies, and (2) to what extent can external data from other government agencies be used by CMS in determining DRG payments for inpatient stays involving new technologies. GAO interviewed officials from CMS and industry stakeholders. GAO interviewed officials from Bureau of Labor Statistics (BLS), Department of Veterans Affairs (VA), Department of Defense (DOD), and Agency for Healthcare Research and Quality (AHRQ) because these agencies may have data useful to CMS. GAO also reviewed regulations and other CMS materials. CMS has used external data for two purposes: to inform DRG reclassification and to evaluate new technology add-on payment applications. To inform DRG reclassification, CMS accepts the submission of external data that are intended to demonstrate that inpatient stays involving a new technology are costlier on average than the other inpatient stays in the same DRG. CMS uses its data from the Medicare Provider Analysis and Review (MEDPAR) file to validate the external data submitted. Specifically, when external data are submitted for a proposed DRG reclassification for a procedure or new technology, CMS's policy is to find the same or similar evidence in the MEDPAR file. Generally, CMS will not make a reclassification decision for a DRG involving a new technology if the technology is so new that it does not appear in the MEDPAR file. To evaluate new technology add-on payment applications, CMS has generally used external data in conjunction with data from the MEDPAR file to evaluate whether a new technology meets one of the three eligibility criteria, specifically the criterion related to cost. Data from other government agencies have limitations for CMS's use in setting DRG payments for inpatient stays involving new technologies. This is because when setting DRG payments, CMS generally needs data that are representative of the Medicare population, timely, and complete in that the data include the total charge or other measure of costliness for all services provided during an inpatient stay, including new technologies. The data we identified from other government agencies were either not representative of the Medicare population, were not timelier than data from the MEDPAR file, or were not complete. Data from the MEDPAR file remain the primary data source for setting DRG payments because they include all charges from paid inpatient claims for inpatient services provided to all Medicare beneficiaries across all hospitals paid under the IPPS. In instances where data from the MEDPAR file have lacked charge information for certain stays involving new technologies, CMS has used external data to inform the DRG reclassification process and to evaluate new technology add-on payment applications. To set DRG payments, CMS needs data that meet criteria of being representative, timely, and complete. Although BLS, VA, DOD, and AHRQ collect data for their own purposes that could potentially be useful to CMS, these data are limited in their utility to set DRG payments because they do not always meet CMS's criteria. In commenting on a draft of this report, CMS stated that it agreed with GAO's findings.