VA’s 157 medical centers serve about 2.3 million veterans each year at a cost of about $14 billion. The Albuquerque medical center provides a wide range of inpatient and outpatient care to about 31,000 veterans who reside primarily in New Mexico, the southern part of Colorado, and the western part of Texas. The center spends about $65 million annually. VA medical centers are authorized to enter into affiliation agreements with nearby medical schools. Through these agreements, VA centers and medical schools may share excess services as a means of improving efficiency of operations and providing patients access to advanced technologies. This may be done through joint acquisition of equipment or contracts that require one party to reimburse the other for the costs of services shared. According to hospital officials, the Albuquerque center currently shares more than 150 medical services, including lithotripsy, with the UNM medical school (see app. II for a detailed discussion of VA’s authority to share services with medical schools). Lithotripsy (in Greek, “stone crusher”) is a process that uses shock waves to fracture kidney stones into pieces small enough to pass through a patient’s urinary tract. While patients may be able to pass smaller stones on their own, many stones are too large to pass through the ureter, which is a gradually narrowing tube within the urinary tract. Before lithotripsy, surgical procedures were often used to remove such stones, requiring a hospital stay. Lithotripsy, by contrast, is generally performed as an outpatient procedure. A specialized piece of equipment—an extracorporeal shock-wave lithotripter—produces the shock waves that break up the kidney stone. Medical personnel needed for the procedure may include a technician to operate the lithotripter, a urologist to monitor and supervise the procedure, and an anesthesiologist or anesthesiology certified registered nurse to administer pain medications and monitor the patient’s overall health during the procedure. Two public and three private hospitals provide lithotripsy in Albuquerque. The Albuquerque VA center provides lithotripsy services to veterans who meet VA’s eligibility criteria. Veterans choosing not to use VA services and nonveterans can obtain lithotripsy services through four other hospitals in Albuquerque—the UNM Health Services Center, a state-operated institution, or three private hospitals (Kaseman Presbyterian, St. Joseph’s, and Lovelace). Each of the latter four hospitals contracts for the use of lithotripsy equipment from one of two sources. UNM has a contract to use VA’s lithotripter at the Albuquerque center; the three private hospitals use a lithotripter supplied under contract with Southwest Therapies, a for-profit company. VA and Southwest Therapies are the only equipment owners in Albuquerque. Previously, hospitals had to send patients needing lithotripsy to health care providers outside the Albuquerque area. The two contractual arrangements for lithotripsy equipment use in Albuquerque differ in several key aspects. The UNM/VA arrangement is based on treatment with a lithotripter permanently located at the Albuquerque center. Under this arrangement, VA provides the site, equipment, technician, nurses, anesthesiologist or anesthesiology certified registered nurse, recovery room, and facility support, while UNM provides the urologist and handles the patient billing services. The arrangement between each of the private hospitals and Southwest Therapies, by contrast, is based on treatment with a mobile lithotripter that is taken to each hospital on a regularly scheduled basis. Southwest Therapies provides the equipment and a technician, while the hospital provides the site, utilities, recovery room, nurses, and other facility support. Under this approach, the urologist and anesthesiologist are private physicians who bill the patient or the patient’s insurance separately for their services, as table 1 shows. Over one-quarter of all lithotripsy procedures for Albuquerque-area patients (353) in 1993 were performed using the Albuquerque center’s lithotripter (see table 2). The procedures were divided nearly equally between VA and UNM patients. Medical centers are generally required to recover the full variable and fixed costs of contract services provided to patients of affiliated medical schools, according to VA’s rate-setting policy. Specifically, the Albuquerque center should include all costs for staffing, equipment usage (including depreciation), supplies, and administration. Variable costs refer to expenses that are incurred only when a lithotripsy procedure is performed, such as staffing, supplies, and administration. For example, if the center used supplies costing $200 for an individual procedure, this amount should be included in the charge. Thus, if 10 procedures were performed, the total cost would be $2,000; likewise, there would be no cost if the center did not perform any procedures. By contrast, fixed costs refer to those expenses that the center incurs regardless of the number of procedures performed. These include equipment depreciation and maintenance, as well as building management. For example, depreciation represents the annual expense of using an asset, such as the lithotripter. Generally, annual depreciation costs are determined by dividing the equipment’s purchase price (less any salvage value) by the number of years of useful life. By allocating this cost evenly over the number of procedures performed, the center can recover its initial investment. The Albuquerque center included the appropriate fixed and variable cost components in its rate-setting process. Nonetheless, the center’s rates were not sufficient to recover all costs. For example, the center charged $1,469 for a basic lithotripsy procedure provided to each UNM patient receiving contract services in 1993. The center had unrecovered costs of $1,894 for each procedure, consisting of $1,670 in fixed costs and $224 in variable costs, as the following sections show. The Albuquerque center incurred total annual fixed costs of $360,387 for lithotripsy services in 1993. The center estimated that a charge of $655 would be sufficient to recover fixed costs in its overall charge for each lithotripsy procedure in 1993. Depreciation costs accounted for the majority of the fixed costs, as table 3 shows. Our analysis showed that a charge of $655 per lithotripsy procedure was not sufficient to recover the center’s fixed costs. This can be seen by comparing the revenues such a charge would produce against the total fixed costs of $360,387 that Albuquerque incurred. Collecting $655 for each of the 155 lithotripsy procedures conducted in 1993 would recover about $101,525, leaving a shortfall of about $258,862 or $1,670 per procedure. This shortfall occurred because the Albuquerque center’s charges were based on an unrealistically high estimate of the total number of lithotripsy procedures it would perform in 1993. The center assumed that its fixed costs would be spread over 882 procedures during the year; the number of procedures actually performed was 155, less than 20 percent of this estimated workload. When we asked how the estimate of 882 had been developed, officials at the center said they based it on a low estimate of the equipment’s annual capacity. VA policy recommends, but does not require, that workload be developed on the basis of a center’s actual usage during the previous year (historical workload) and expected usage under new sharing agreement(s) (potential demand). If this approach had been used by the Albuquerque center, workload would have been estimated at 256 procedures—140 veterans and military beneficiaries served in 1992 and 116 patients targeted in the UNM contract for 1993. Our discussions with center officials indicated that they were unaware of this suggested workload estimating methodology when they developed their 1993 workload estimates. VA’s policy also recognizes that the accuracy of projections will greatly affect the charges assessed for a service that is provided under a sharing agreement with an affiliated medical school. Accordingly, VA recommends that the projected total workload be reviewed quarterly and the charges be adjusted if the revised workload estimate shows the per-procedure cost would change by more than 5 percent. Officials at the center made no effort to revise the charges for the fixed-cost components during 1993 and said that they were unaware of this provision. During 1993, the number of procedures averaged 39 per quarter, with a low of 34 in the second quarter. That the number of procedures performed would be well below the estimated workload was clear early in 1993. Adjustments should have been made to the charges then but were not. To illustrate the effect of this overstated workload on the center’s recovery of contract lithotripsy costs, we examined the center’s charge of $1,469 for a basic lithotripsy procedure. The center’s basic charge may be divided into two cost categories—$755 for the lithotripter and technician and $714 for facilities support, including anesthesiology services. These categories are consistent with those used by other Albuquerque lithotripsy providers and they facilitate our comparative analysis with these providers. Each category contains variable costs (staffing, supplies, or administration) as well as fixed costs (equipment depreciation and maintenance or building management). To estimate the amount of unrecovered costs, we compared the center’s 1993 charges for these cost categories using the center’s workload estimate of 882 and its actual workload of 155 procedures. To fully recover the Albuquerque center’s fixed costs spread over the 155 procedures provided, the center would have needed to charge about $3,360 rather than the $1,469 it actually charged. These charges are summarized in table 4. In February 1994, the center revised its lithotripsy charge for UNM patients. This revision included an adjustment in the expected number of procedures as well as changes to key assumptions and cost data. Because these adjustments had an offsetting effect, there was essentially no change in the rate—$1,451 for 1994, compared with $1,469 for 1993. Two key assumptions in the center’s calculations indicate that the center may again recover only a small portion of the fixed costs of lithotripsy services provided to UNM patients. The Albuquerque center computed its 1994 prices on the assumption that it would conduct 500 lithotripsy procedures at the center in 1994. While this represents a 43-percent reduction from the center’s estimate of 882 a year earlier, it still appears unrealistic given the experience of the past several years—140 procedures actually conducted in 1992 and 155 procedures actually conducted in 1993. Center officials were not able to offer support for their projection that the number of procedures would more than double. The center’s estimated workload would have been 223 procedures if it had been developed on the basis of historical workload and potential demand under UNM’s sharing agreement. During 1993, the center conducted 107 procedures on veterans and military beneficiaries, and the UNM sharing agreement calls for it to provide 116 procedures in 1994. The center’s charge of $1,451 should fully recover costs if the estimated workload (500 procedures) is performed. However, a higher charge would be needed to cover costs if fewer procedures are performed. As of June 30, 1994—halfway through 1994—the center had performed 97 procedures and we were told that the rate of utilization was not expected to increase significantly. Although adjustments to the charge appear warranted, Albuquerque center officials told us that they have no plans to do so. Albuquerque center officials computed the 1994 charges on the assumption that the lithotripter’s initial acquisition costs would be depreciated over a period of 9 years—4 years longer than the period used to determine the 1993 charges. Center officials told us that this adjustment was made to reflect the lower than anticipated utilization rate during the first 2 years of operations. Extending the recovery period reduces the amount of acquisition costs to be recovered each year and, hence, the amount charged for each procedure performed. Although the lithotripter’s manufacturer has guaranteed the Albuquerque center that service and parts will be available for 10 years, technological advances in medicine are sometimes so rapid as to call into question an assumption that a piece of equipment like a lithotripter will not become technologically obsolete before it reaches the end of its useful life. Using such a long recovery period increases the risk that its costs will not be recovered before the treatment of kidney stones moves on to new equipment or other types of medical procedures. In this regard, Southwest Therapies told us that they are depreciating their lithotripters over a 5-year period. VA policy calls for annual depreciation costs to be calculated using the actual purchase price, less any assigned salvage value, divided by the number of years of expected useful life. In its 1993 depreciation determination, the Albuquerque center assumed a 5-year useful life, with no resulting salvage value. On this basis, the annual depreciation for the lithotripter was $249,645, which represents one-fifth of the lithotripter’s purchase price ($1,248,225). Because of the low utilization, the center realized only $120,360 of the almost $500,000 (less than 25 percent) expected during the first 2 years of operation. As a result, the center has yet to realize $1,127,865 in depreciation costs. VA policy does not provide guidance for developing a change in the estimated useful life of equipment. However, generally accepted accounting principles provide that when a change in estimated useful life is determined to be necessary, the remaining value of the asset is to be divided by the remaining estimated life. In setting the 1994 charges, the center’s officials extended their estimate of the lithotripter’s useful life from 5 years to 9 years. This gave the center 7 years (1994-2000) to depreciate the remaining acquisition costs rather than the 3 years remaining from their original estimate of a 5-year useful life. This change should have resulted in an annual depreciation cost of $161,124, or a per-procedure charge of $322 spread over the center’s annual workload estimate of 500 procedures, if done in accordance with generally accepted accounting principles. However, the center’s officials decided to ignore the first 2 years of accumulated depreciation realized ($120,360) and divided the total acquisition costs of $1,248,225 by the estimated 7 years of remaining useful life. This resulted in an annual depreciation cost of $178,318, or a per-procedure charge of $357 spread over 500 procedures annually. In effect, this approach would fully depreciate the lithotripter’s costs in a little over 6 years. To illustrate the effects of these assumptions on the center’s basic lithotripsy charge, we evaluated what would happen if the center had used a more reasonable workload estimate of 223 procedures (computed as suggested by VA’s policy) rather than 500 and a depreciation period of 5 years (as used in 1993 pricing structure) rather than 9 years. In all, changing the assumptions in this way would result in a 1994 charge of about $3,271 rather than $1,451. For the lithotripter and technician, the charge would rise from $658 to about $2,168, of which $1,686 represents depreciation costs. For facilities support, the charge would rise from $793 to about $1,103. Appendix VI provides further details on how we developed these estimates. To assess how the center’s assumptions about the lithotripter’s useful life affect the center’s charges, we estimated annual depreciation costs for periods of 3, 5, and 7 years, using a workload estimate of 223 procedures. For these time periods, the center’s charges to recover the remaining acquisition costs ($1,127,865 as of January 1994) range between $723 and $1,686 as table 5 shows. By charging UNM for less than half of its 1993 costs to provide basic lithotripsy procedures, the Albuquerque VA center is not recovering its equipment depreciation costs. More specifically, the center did not charge UNM about $91,000 of the costs of the 48 lithotripsy services provided to UNM patients in 1993. The unrecovered costs averaged nearly $1,900 per procedure. In theory, UNM could keep the entire savings or it could pass some or all of it on to patients or their insurers. Our analysis of UNM’s pricing actions suggests that both situations occurred in 1993. Also, a comparison of rates charged by UNM and other providers suggests that VA could fully recover its costs and remain competitive in the Albuquerque market. As previously discussed, to fully recover its fixed and variable costs, VA should have charged about $3,360 for each of its basic lithotripsy procedures in 1993, rather than the $1,469 per procedure charge. The effect of VA’s price to UNM is difficult to determine precisely because there is not always a direct relationship between a service’s cost and its price in a complex, competitive market. A provider may have, in effect, several prices for the same procedure. For example, a hospital may have a different charge for certain types of insured patients and those paying individually. In addition, an insurer may have a policy of not paying beyond a specified amount, even if the hospital’s charge is higher. Also, one insurer may negotiate a rate that is different from the rate the hospital submits to other insurers or to individual patients. For most of 1993, UNM appears to have greatly benefited by its contract with VA. While UNM paid the Albuquerque VA center only $1,469 for each procedure, UNM’s lithotripsy charge to individuals and insurance companies was the highest in the area. UNM kept some or all of the savings in the form of increased revenues. Table 6 shows the breakdown of charges under the most prevalent UNM rate during 1993 and under one of the private hospital/Southwest Therapies packages. While UNM’s total charges under the two packages were the highest, the charges were relatively comparable ($9,029 vs. $7,977). However, the breakdown of charges for service components shows major differences, two in particular. First, the center’s charge of $755 for the lithotripter and technician was about one-quarter of Southwest Therapies’ charge of $2,920. Second, the combined Albuquerque VA’s and UNM’s charges of $5,750 for facilities support were over twice the $2,617 charge of the private hospital. Toward the end of 1993, changes in UNM’s pricing for lithotripsy services may have had the effect of passing the savings to UNM patients, insurers, and health maintenance organizations in the form of lower rates. In October 1993, UNM reduced its existing charge for lithotripsy from $9,029 to $6,950, a 23-percent reduction. UNM’s Chief Financial Officer said that UNM did so after deciding that its charges for lithotripsy were too high. The reduction came entirely from UNM’s portion of facilities support. At about the same time, UNM also negotiated an even lower lithotripsy rate of $3,550 with a local health maintenance organization. This 49-percent reduction in the $6,950 rate, came from two places: a reduction of $1,180 in the urologist’s fee, and a reduction of $2,220 in UNM’s facilities support charges. Table 7 shows a breakdown of these two new rates. In commenting on a draft of this report, the Vice President for Health Services, UNM, explained the rationale for the reduction. A large percentage of the discount, she said, is because patients enrolled in this health maintenance organization have their prelithotripsy work-up and postlithotripsy follow-up performed by private urologists, and the UNM urologists and UNM clinical facilities are engaged for only that portion of care directly associated with delivery of lithotripsy treatment. She noted that the remainder of the discount is associated with increased volume, case management, and similar factors that ordinarily provide the basis for offering discounts from usual and customary charges to managed care organizations. During 1994, UNM discussed the possibility of providing lithotripsy services with another health maintenance organization. This health maintenance organization purchases lithotripsy from one of the private Albuquerque hospitals. The negotiations have included a number of factors, including cost. At this time, however, UNM and the health maintenance organization have postponed further negotiations until our concerns about VA’s charges are resolved. The effect of changes in the center’s pricing practices on its competitiveness in the market for lithotripsy services in Albuquerque is also difficult to determine precisely. This occurs because the center’s price is only one of many variables, including access and re-treatment rates, that may affect decisions about which providers of lithotripsy services to use. On the basis of price, it appears that the Albuquerque center could comply with VA policy by charging enough to fully recover its costs and still offer a price that is competitive with the services provided by Southwest Therapies and other providers. For example, the center’s 1994 price for use of the lithotripter and technician is $658; Southwest Therapies’ price is $2,920. If the center charged a price that fully recovered costs within 5 years, the charge for this portion of its services would be about $2,168—still below Southwest Therapies. Likewise, it appears, on the basis of price, that UNM could pay the Albuquerque center for the full costs and still charge insurers and others a price that is competitive in the Albuquerque market. For example, since October 1993, the regular price for the UNM service has been $6,950; bills from private hospitals indicate that the total price for the service they offer with Southwest Therapies remains between $8,000 and $9,000. If the center charged a price for its lithotripter and technician ($2,168) and facilities support and anesthesiology ($1,103) that fully recovered costs within 5 years, the charge to UNM would need to increase by about $1,820 over the $1,451 now charged. If UNM passed on all of these costs to patients and insurers, its regular charge would increase to about $8,770. In theory, patients have the flexibility to choose among the various lithotripsy providers. Clearly, patients who pay their own medical bills or who have medical insurance, such as Blue Cross/Blue Shield, have greater latitude in selecting providers. If they belong to a health maintenance organization, patients seeking lithotripsy treatment may have less choice in where they can go to obtain services. Such organizations may have contracts with specific hospitals for such services. For example, HealthPlus, a local organization, contracts for services from Kaseman Presbyterian Hospital. However, some health maintenance organizations, such as QualMed, may contract for lithotripsy services with more than one hospital. When selecting a lithotripsy provider, patients’ choices may be affected by the recommendation of the urologist or other specialist who diagnosed their condition. Medical and administrative staff of the Albuquerque lithotripsy providers and user organizations indicated that several factors, in addition to cost, could also play a part in patients’ decisions, as discussed below. Scheduling of services could potentially vary substantially between providers. The private hospitals rely on a lithotripter that Southwest Therapies transports from hospital to hospital on a regular schedule. This lithotripter is generally at a hospital only 1 or 2 days a month and, as such, may not always be available when needed. By contrast, the Albuquerque center generally schedules UNM patients for one day each week, but the center also treats these patients on other days, if medically necessary. The types of anesthesia vary between providers, generally due to the type of lithotripters used. The private hospitals use general anesthesia, which produces complete unconsciousness, muscular relaxation, and absence of pain sensation during the procedure. These hospitals use the Southwest Therapies’ lithotripter and the manufacturer recommends the use of general anesthesia with that equipment. UNM uses local anesthesia as recommended by the manufacturer of the lithotripter used by the Albuquerque center. Local anesthesia produces muscular relaxation and absence of pain sensation in a limited part of the body; patients maintain consciousness during the procedure. Many health care practitioners regard local anesthesia as somewhat less risky than general anesthesia because it decreases the chance of complications or potentially bad outcomes. Southwest Therapies and VA have re-treatment rates that vary. Re-treatment rates refer to the frequency which patients must return for a second treatment because the first was not effective. Re-treatment may be needed, for example, if the stone did not fracture sufficiently to pass through the patient’s system. According to a VA urologist, the national re-treatment rate is about 20 percent. By comparison, the Albuquerque center reported a re-treatment rate of 15 percent and Southwest Therapies reported a rate of about 5 percent. Both providers require full payment for any re-treatment. The Albuquerque medical center’s charges for lithotripsy services do not recover the full costs of services provided. The main reason for the problem—a flawed price-setting methodology—can be corrected. First, the Albuquerque medical center should develop the lithotripsy charges using a workload estimate that is based on historical workload for veterans and potential demand under sharing agreements. Second, the center should include an equipment depreciation cost that is based on a shorter useful life. Without such actions, it seems likely that the Albuquerque center’s pricing practices will continue to fail to recoup costs and may adversely affect the market for lithotripsy services in the Albuquerque area. The Secretary of Veterans Affairs should direct the Director of the Albuquerque medical center to raise the price of lithotripsy services provided to nonveterans to a level that will recover the full fixed and variable costs of the services provided, as VA policy requires; and implement a process for periodically reviewing the adequacy of workload projections as VA procedures recommend, and use the results to adjust prices, as appropriate. We requested written comments on a draft of this report from the Department of Veterans Affairs and the University of New Mexico School of Medicine. The University’s Vice President for Health Sciences, in a letter dated October 18, 1994 (see app. VII), provided some clarifying observations that are included in the report where appropriate. However, she declined to offer an opinion on the appropriateness of VA’s pricing policies and procedures. The Secretary of Veterans Affairs provided written comments in an October 31, 1994, letter (see app. VIII) wherein he agreed that the Albuquerque medical center has not been recovering the full costs of its lithotripsy services provided to UNM. He also agreed with our assessment of why this situation occurred—a flawed price-setting methodology that set usage rates significantly higher than the actual rate. The Secretary, however, disagrees with our recommendations. First, he does not believe that the center’s lithotripsy prices should be raised to a level that will recover the full costs of the services provided. Rather, he prefers to raise the basic lithotripsy price by only $162, a significantly lower amount than is needed to fully recover costs. Second, he prefers to allow the center to review prices on an annual rather than on a quarterly basis as VA policy recommends. In our draft report provided for the Secretary’s review, we had recommended that the Albuquerque center adhere to VA’s policy. While we agree that annual pricing reviews may be a reasonable alternative, we disagree with the Secretary’s view that the center should not be required to fully recover costs. Depending upon the number of years that VA chose to recover its acquisition costs for the Albuquerque lithotripter, the medical center, in our opinion, would have recovered the full costs of its basic lithotripsy service in 1994, if it had charged between $2,308 and $3,271 per procedure. The lower charge could recover initial equipment acquisition costs over a 9-year period, whereas the higher charge could achieve full recovery in 5 years. Toward this end, we recommended that the Albuquerque center raise its price to achieve full cost recovery and indicated in the report our preference that such recovery be achieved in the shortest time period possible; that is, 5 years rather than 9 years. “a methodology that provides appropriate flexibility to the heads of facilities concerned to establish an appropriate reimbursement rate after taking into account local conditions and needs and the actual costs to the providing facility of the resource involved.” He also indicated that it is consistent with cost recovery practices that other VA medical centers have developed to price contract services involving low-volume, high-technology equipment. The Secretary concluded that the Albuquerque medical center qualifies to use a low-volume, high-technology equipment pricing practice because its lithotripter has an annual workload of 200 procedures. He explained that this practice involves a different methodology for determining the amount of equipment depreciation costs to be recovered per procedure than the one previously used in 1993 and 1994. In 1993 and 1994, the center used a methodology that allocated the equipment acquisition costs ($1,248,225) over the number of procedures to be actually performed during the equipment’s useful life (9 years). For example, the center expected to recover $178,318 in each of the 9 years and, using a projected workload of 500 procedures in 1994, included a charge of $357 in its basic lithotripsy price ($1,451) for that year. The 1995 methodology bases the depreciation charge on the number of procedures the equipment is capable of performing during its useful life. In this case, the center estimates that the equipment can perform 4,500 procedures in its life and, as such, decided to recover depreciation costs of $250 per procedure, or 1/4,500 of the equipment acquisition cost ($1,248,225 minus salvage value of $124,823). We find the Secretary’s approval of this methodology to be troublesome for several reasons. In general, it exposes the medical center (and taxpayers) to an unreasonably high risk of a large unrecovered equipment acquisition cost; ignores local market conditions, which seem to indicate that a faster recovery of equipment cost (and lower risk of unrecovered costs) is possible; and ignores the impact that such pricing practices may have on the competitive environment in the Albuquerque lithotripsy market. The Albuquerque medical center’s 1995 pricing methodology would result in a slower recovery of equipment acquisition costs than the center’s previous pricing practice—a situation that greatly increases the likelihood of potentially large unrecovered costs. The amount recovered will drop from $357 per procedure in 1993 to $250 in 1994. As a result, the center will recover about $50,000 a year compared with $71,000 at current usage rates of about 200 procedures a year. If usage continues to average 200 procedures a year, the center will recover less than half of the equipment acquisition costs, unless the equipment’s useful life greatly exceeds 9 years (the useful life that the center used in setting its 1994 price). Over a 9-year period, the center could expect to perform about 1,800 procedures, which would recover $450,000 of the almost $1.2 million acquisition costs. In contrast, the center would need to operate the equipment for 25 years to fully recover costs at current usage rates of 200 procedures per year. This seems unrealistic in that (1) the manufacturer has guaranteed parts for and maintenance of the lithotripter for only 10 years and (2) advances in medical technology would likely render the equipment obsolete well before the end of 25 years. It appears that VA will need an almost three-fold increase in utilization (about 500 procedures) if it is to fully recover costs within 9 years under its pricing policy. Given that there were only 353 procedures performed by all lithotripsy providers in Albuquerque during 1993, it seems that the center would have trouble reaching this utilization level even if all demand for lithotripsy services shifted to UNM. The local market in Albuquerque for lithotripsy services consists of two equipment providers—Southwest Therapies and the Albuquerque medical center. As pointed out in our report, Southwest Therapies charges medical facilities $2,920 per procedure for use of its lithotripter and technician compared with the Albuquerque center’s charge of $755 for use of its lithotripter and technician. In 1993, three hospitals in Albuquerque purchased 259 procedures from Southwest Therapies. Thus, it seems that the Albuquerque center could raise its price—to cover a more reasonable depreciation charge—by over $1,300 and still offer UNM a competitive alternative to the market price. The Albuquerque center’s below-cost pricing practice may also affect the competitive environment in the Albuquerque lithotripsy market because such a practice greatly increases the disparity between the costs for the use of lithotripter and technician paid by UNM and other competing hospitals. Because the Albuquerque center will continue to charge UNM less than half of the depreciation costs, the center, in effect, is underwriting the costs of lithotripsy services provided to UNM’s patients—a pricing practice that appears to foster an unlevel playing field in the Albuquerque lithotripsy market. The Secretary, in an attachment to his letter, indicated that the center considered UNM’s charges to third parties when it determined its prices. In this regard, it suggests that UNM’s charges do not equate to receipts, given that UNM serves indigent patients. While there may be some rationale for reducing the costs of care for UNM’s indigent patients, we find it difficult to comprehend why VA would want to subsidize the costs of care provided to UNM’s insured patients. Our analysis of UNM’s charges indicates that it is passing on the savings to its customers in the form of lower prices and retaining some or all of the savings for its own use in certain situations. As we pointed out earlier, a local health maintenance organization contracted with UNM to obtain a greatly reduced rate of $3,550 for the entire service, including the attending physician. This $3,550 price represents a 55-percent reduction from the price charged by a private hospital providing lithotripsy in the Albuquerque market. Also, as discussed earlier, another local health maintenance organization has inquired about purchasing UNM’s services. Such large price reductions would seem to provide a powerful incentive for other organizations to contract for use of UNM’s services. The Secretary noted that he will ask VA’s Assistant Secretary for Finance and Information and Resources Management, as well as VA’s Under Secretary for Health, to examine VA’s policies and assess their continued appropriateness to enable VA to recover its actual cost. We support this action and strongly urge the Assistant Secretary and Under Secretary to revise the center’s pricing practice so that it reduces the government’s risk of potentially large unrecovered equipment costs, while appropriately taking into account local market conditions so as to maintain a fair and competitive environment for lithotripsy providers in Albuquerque. VA policy appropriately states that medical centers should be fully reimbursed for the costs of services provided to affiliated medical schools (such as UNM). But in this case, the Secretary concludes that the Albuquerque center’s 1995 pricing practice is appropriate for low-volume, high-technology equipment, even though the pricing practice does not fully recover equipment costs. In fact, the center sold a service to UNM for $1,451 in 1994 and will sell it for $1,613 in 1995, when the service actually costs between $2,308 and $3,271. This looks like a bad business deal for VA (and taxpayers) and a good business deal for UNM. In summary, we believe that VA’s pricing policy should adhere to a guiding principle that equipment acquisition costs should be recovered as quickly as market conditions allow. Toward this end, we continue to recommend that the medical center raise its price to a level that will recover the full costs of lithotripsy services within the shortest possible time period. We continue to favor the center’s original methodology; that is, spreading the depreciation costs evenly over a prescribed recovery period and basing the charge on the expected number of procedures to be actually performed during each year, as long as the charges are competitive in the market. In our draft report, we recommended that the Albuquerque center implement a process to review the adequacy of workload projections on a quarterly basis, as VA policy recommends. In his response, the Secretary said that annual reviews would be more appropriate. Our recommendation was aimed at bringing the Albuquerque center into compliance with VA’s policy because we found quarterly reviews to be a reasonable approach. We do not disagree with the Secretary’s views that annual rather than quarterly reviews could meet VA’s pricing requirements. Given the Secretary’s desire to require annual reviews for the Albuquerque center, we believe that it would be appropriate for the Secretary to update VA’s policy statement on workload reviews so that it advises other centers that annual reviews are acceptable. As such, we have modified our recommendation to require the Albuquerque center to implement a process for periodically reviewing the adequacy of workload projections. Unless you publicly announce its contents earlier, we plan no further distribution of this report for 30 days. At that time, we will send copies to the Secretary of Veterans Affairs and interested congressional committees. We will also make copies available to others upon request. This report was prepared under the direction of Paul Reynolds, Assistant Director, Federal Health Care Delivery Issues. Please call Mr. Reynolds at (202) 512-7101 or Linda Bade, Senior Evaluator, at (503) 235-8507 if you or your staff have any questions. Susan Poling, Assistant General Counsel, also contributed to this report and can be reached at (202) 512-5881. Other evaluators who made contributions to this report include Dwayne Curry, William Stanco, and Stanley Stenersen. At the Albuquerque center, our work focused on reviewing the center’s agreement for the sharing of lithotripsy services and assessing whether the prices charged were fully recovering costs as stipulated in VA policy guidance. To obtain background on the issue, we discussed with Albuquerque center officials the factors that were involved in the decision to acquire lithotripsy equipment and to enter into a VA/UNM sharing agreement. To help ensure that we fully understood VA policy on the pricing of shared services, we also talked with VA headquarters officials from the offices in charge of surgical services and sharing with other institutions. To help assess the agreement’s pricing structure, we held discussions with officials at the Albuquerque center, including the Director, Associate Director, Chief of Quality Management (who has responsibility for oversight of lithotripsy services), and members of the center’s fiscal office. These officials explained the processes that were used to develop the center’s price for lithotripsy services in 1993 and 1994, including a detailed description of the individual cost components. They also described the methodology used to allocate costs for each component and provided documents supporting the cost data used. We compared the center’s pricing processes to VA’s policies and guidance and tested the reasonableness of the documentation provided. We also reviewed VA’s utilization and billing records for the nonveterans served under this sharing agreement in calendar year 1993 and confirmed these against similar documentation obtained from UNM. Our work at UNM focused on activities relating to its contract with VA for lithotripsy services. We discussed the sharing agreement and UNM’s related pricing information with officials in the finance and managed care offices at UNM. We obtained and analyzed utilization, billing, and other records relating to the treatment of UNM patients, as well as UNM’s pricing of the services it provided. We also discussed negotiations UNM was conducting with regard to providing lithotripsy services for other medical facilities or health maintenance organizations in the Albuquerque area. We also obtained pricing information for the services provided by other hospitals providing lithotripsy in the Albuquerque area—Kaseman Presbyterian, St. Joseph’s, and Lovelace. At VA and UNM, we had access to all records, because the providers are government agencies; at these other providers, which are all private institutions, our access to information was limited to those utilization and pricing documents that they were willing to provide. Specifically, we obtained a sample of actual bills for lithotripsy services that the providers told us were representative of their charges, and we discussed the processes the providers used to develop the charges billed. At Southwest Therapies, the only other provider of lithotripsy equipment in the Albuquerque area, we obtained and reviewed 1993 billings and utilization data. We compared the service provided, the financial data, and the utilization information we obtained with the information supplied by the Albuquerque center, conducting follow-up discussions as needed. At the three private hospitals in the Albuquerque area (Kaseman Presbyterian, St. Joseph’s, and Lovelace), we interviewed hospital officials and obtained sample billing documents and other related documentation. To the extent possible, we compared the information provided with the information obtained from the Albuquerque center and UNM. To help gain an understanding of how the Albuquerque center’s pricing actions might be affecting the market for lithotripsy services in the Albuquerque area, we spoke with officials at the three hospitals and with an official of a local health maintenance organization (QualMed) about their desire to either change their current service provider or expand their own capabilities in the provision of these services. We also discussed the provision of anesthesia services connected with lithotripsy (as it is provided at Kaseman Presbyterian Hospital) with the Anesthesiology Medical Consultant’s Group in Albuquerque, New Mexico. We obtained data related to how anesthesiologists develop their per-procedure rates and a range within which they might bill for such services. Our review was performed from January 1994 to August 1994 in accordance with generally accepted government auditing standards. Title 38, section 8153 of the United States Code provides VA with contracting authority to share specialized medical resources with non-VA health facilities. These contracts are generally called sharing agreements (38 U.S.C. section 8153 (Supp. IV 1992), as amended by P.L. 103-210, section 3(c), Dec. 20, 1993). Under the statute, sharing agreements may not result in “diminution of services to veterans” (38 U.S.C. section 8151 (Supp. IV 1992), as amended by P.L. 103-210, section 3(a), Dec. 20, 1993). Specialized medical resources are defined to include equipment, space, or personnel, which are either unique in the medical community or are subject to maximum utilization only through mutual use because of cost, limited availability, or unusual nature (38 U.S.C. section 8152(2)(Supp. 1992) as amended by P.L. 103-210, section 3(b), Dec. 20, 1993). VA can use section 8153, for example, to share equipment it owns with outside providers or to gain access to equipment owned by others. Sharing agreements may be used to secure specialized medical resources that otherwise might not be feasibly available or to effectively utilize certain other medical resources when the Secretary determines it is in the best interest of the prevailing standards of the Department medical care program. However, under section 8153, the Secretary may only enter into sharing agreements if the contract will obviate the need for a similar resource to be provided in a VA facility or the VA resources that are the subject of the agreement and that have been justified on the basis of veterans’ care are not used to their maximum effective capacity (which is the case with the lithotripter at the Albuquerque center). The law is not very specific with regard to how VA is to price the medical resources that it provides to medical schools, health care facilities, and research centers. The law states that reimbursement must be based on a methodology that provides appropriate flexibility to the heads of VA facilities after taking into account local conditions and needs and the actual costs to the providing facility of the resource involved. The guidance (VA Manual, G-13, M-1, Part I, p. 3, Mar. 11, 1986) in effect when the VA Albuquerque entered into its sharing agreement with the University of New Mexico Medical Center for lithotripter services generally required that charges cover the full cost of services rendered; supplies used, including normal depreciation; and amortization of equipment, according to life expectancy. In commenting on a draft of this report, the Secretary of Veterans Affairs approved the use of an alternative pricing practice for low-volume, high-technology equipment contained in VA Manual G-12, M-1, Part 1, appendix B. This pricing practice may not fully recover costs. (see app. VIII.) The current VA manual states that when a proposed sharing agreement involves the contractor’s use of federally owned property, such as medical space or medical equipment (which is the case with the lithotripter at Albuquerque), VA should obtain a fair market value in accordance with comparable commercial practices. The negotiated cost need not be limited to the recovery of costs and may produce net revenue to the government (M-1, Part 1, chapter 34, July 14, 1993). The guidance also references OMB Circular A-25 (Sept. 23, 1959), which includes in its definition of full cost an appropriate share of depreciation of equipment; this circular provides a basis upon which user charges are to be set. Another provision of Title 38 permits VA to enter into agreements with institutions for the joint acquisition of medical equipment (38 U.S.C. section 8157 (Supp. IV 1992)). Under this provision, the Secretary may not pay more than one-half of the purchase price, the equipment must be jointly titled to the United States and the institution, and the Secretary and the institution must have arranged by contract under 38 U.S.C. section 8153 for the exchange or use of the equipment before the equipment is acquired. Although this section does not apply to the Albuquerque acquisition, other VA medical centers have jointly purchased lithotripters in partnership with affiliated medical schools. Medical centers are to recover the full cost of contract services provided to patients of affiliated medical schools, according to VA’s rate-setting policy. Specifically, the Albuquerque center must charge, at least, all fixed costs for equipment and building usage. The Albuquerque center incurred an annual fixed cost of $360,387 to provide lithotripsy services to veterans and nonveterans in 1993, as table III.1 shows. This appendix explains how the estimates for each of these cost components were developed. Depreciation represents the expense of using an asset such as the lithotripter. VA policy calls for annual depreciation costs to be calculated using the actual purchase price, less any assigned salvage value, divided by the number of years of expected useful life. In its initial depreciation determination, the Albuquerque center assumed a 5-year useful life, with no resulting salvage value. On this basis, the annual depreciation for the lithotripter was $249,645 which represents one-fifth of the lithotripter’s purchase price ($1,248,225). This cost component covers the contract with the manufacturer for service and repair of the lithotripter and associated component parts. The cost for this category ($72,865) was the actual cost of the maintenance and repair contract for 1993. This component covers such costs as utilities and general maintenance for the area where the lithotripter is located. VA policy calls for establishing the general cost within this category by determining what percentage of the facility’s total square footage is devoted to the medical procedure and applying this percentage to the facility’s total engineering and building management costs. Our 1993 estimate uses the amount ($37,877) developed by the center. Our analysis was based mainly on the center’s basic level of lithotripsy services. However, the center has four levels of services, each one involving some differences in terms of the amount of time, equipment, material, supplies, and staff resources involved in conducting the procedures. The four are as follows: Basic procedure: encompasses the fracturing of kidney stones by the lithotripter without the need for additional procedures or instrumentation. Cystocopsy: involves the use of special instruments and equipment to perform related urology procedures as well as lithotripsy. Uteral catheterization: involves the placement of a uteral catheter to assist in the visualization of some types of kidney stones under X ray. Lithotripsy is performed after the placement of this catheter. Stent: the most time consuming of the four levels, this involves placing a tube in the patient’s ureter, usually after lithotripsy, in order to allow the kidney to drain properly and to relieve pain. In addition to these four levels of services, the Albuquerque center also provided the option of conducting the procedure at any of the four levels using VA’s staff urologist or a certified urologist from the UNM Health Services Center. This means that each level of service has two rates—one including the cost of the VA urologist, the other not including it. Table IV.1 shows the resulting eight rates for the four levels of service as they were specified in the original sharing agreement for 1993. The rates range from $1,469 for a basic procedure without a VA-supplied urologist to $2,216 for a procedure using a stent and with a VA urologist performing the procedure. Under the contractual agreement, these services include equipment, space, materials, ancillary services (such as X ray), and the following staff costs: physician assistant, registered nurse, anesthesiologist, technician, and secretarial services. The rates include depreciation and maintenance, which are discussed in more detail in appendix III. To fully recover its costs for a basic lithotripsy procedure in 1993, the Albuquerque center would have needed to charge about $3,360 rather than the $1,469 it actually charged. The charge of $3,360 per procedure would have been consistent with VA policy, which requires that the price for services sold under sharing agreements should recover the full cost of services rendered and supplies used, including the depreciation cost of equipment. This price is to include the following cost components: staffing, supplies, equipment (depreciation and maintenance), administration, and engineering and building management. This appendix compares the center’s actual costs for the major cost components of its basic lithotripsy service to the amounts the center charged for each component. The Albuquerque center’s $1,469 charge may be separated into two parts: a $755 charge for operation of the lithotripter, including the services of a a $714 charge for facilities support, including anesthesiology services. The $1,469 charge would have recovered the center’s costs if the center had performed 882 procedures or more in 1993. However, the center only performed 155 procedures and, as a result, did not recover $258,862 of the $360,387 in fixed costs spent to provide lithotripsy services. As the following sections show, most of the shortfall relates to the center’s charge for operating the lithotripter and only a small portion was attributable to the center’s charge for facilities support. We estimate that the Albuquerque center should have charged $2,224 for its lithotripter and technician, rather than the $755 charged. Most of this difference relates to the allocation of depreciation costs over 882 procedures rather than 155 procedures. Table V.1 separates the difference by the specific cost components included in the charge. VA’s calculations for staffing were not affected by its overestimation of the number of procedures that would be performed in 1993. This is because staffing costs are assessed on a procedure-by-procedure basis, not on estimated workload. VA policy calls for staffing costs to include professional administration and quality control, clerical and technical support personnel, and fringe benefit and bonus amounts associated with these categories. Salary, fringe, and bonus costs were computed based on average salaries for the classes of staff involved in the procedure, not on salaries for the individual staff actually participating in a particular procedure. Although this approach is likely to produce some distortions in individual cases, it would be difficult for the center to account for each variation that could exist. As a result, we found the center’s determination of costs to be consistent with VA’s policy. For 1993, the center’s fiscal staff used $1.8 million as the purchase amount for the lithotripter, adopted a period of 5 years as the lithotripter’s useful life, assumed it would have no salvage value at the end of the 5-year period, and divided the resulting depreciation amount of $360,000 by 882 estimated procedures to arrive at a per-procedure equipment depreciation charge of $408. This amount was incorrect for two reasons. First, the computation was based on the amount that had been obligated for the lithotripter rather than its actual price. The obligated amount was $1.8 million, but the purchase price was $1,248,225—a difference of $551,775. This created an overstatement of $110,355 in the annual depreciation expense allocated to the 882 lithotripsy procedures. The second reason was the use of the unrealistic workload, and it had the opposite effect—it understated the per-procedure cost. Because the center performed only 155 total procedures instead of the estimated 882, each procedure understated the depreciation amount by more than $1,900. Adjusting this amount to account for the understatement caused by using the incorrect price, the difference between the center’s actual depreciation charge and our recalculated amount was $1,203. A related consideration is whether a salvage value could have been assigned to the equipment, thereby decreasing the depreciation amount. A representative of the company manufacturing the lithotripter told us that the maximum salvage value after a 10-year period would be 20 percent of the purchase price or about $250,000. The representative said his company had guaranteed service and repair for 10 years from the date of purchase—5 years beyond the useful life assigned for depreciation purposes. After that time, the company did not guarantee that parts would be available. The representative said medical technology advances would also affect the equipment’s resale value during the 10-year period. Because of these uncertainties, we accepted the Albuquerque center’s judgment that no salvage value should be included in the depreciation cost estimate. The same two factors that caused errors in the equipment depreciation charge also caused errors in the charge for equipment maintenance and repair. When the charge for this component was developed, the actual contract price had not been determined. Thus, the charge was based on an amount equal to 10 percent of the $1.8 million that had been obligated to buy the lithotripter. This amount overstated the actual amount of the maintenance contract by $107,135. However, as with the charge for depreciation, the overstatement is dwarfed by the understatement that resulted from dividing the total by 882 expected procedures. If the charge is recomputed using the actual price of the contract and the actual number of procedures performed, the per-procedure amount would be $470, which is $266 more than the center actually charged. To fully recover costs, we estimate that the Albuquerque center would have needed to charge $1,139 per procedure for facilities support and anesthesiology, rather than the $714 charged. This difference relates to the insufficient allocation of costs for administration and building management over 882 procedures instead of 155 procedures. Table V.2 separates the difference by specific cost components included in the charge. Because staffing and supply costs are calculated on a per-procedure basis, they are unaffected by the center’s overestimate of the number of procedures that would be performed in 1993. As previously discussed for the lithotripter and technician, we found the center’s determination of staffing costs to be consistent with VA’s policy. VA guidance calls for the cost of supplies to be based on the actual acquisition cost. As with staffing costs, we made no adjustments to the center’s determination of supply costs. This component covers the Albuquerque center’s indirect administrative staff and resource costs related to the providing of lithotripsy procedures. It also reflects two other factors related to the center—building depreciation and interest on net capital investment—as well as administrative costs for VA’s central office in Washington, D.C. The administrative portion is the prorated share of headquarters administrative costs assigned to the Albuquerque center, which is 1 of 157 VA medical centers throughout the nation. The center’s indirect administrative staff and resource costs are based on determining what percentage of direct care (as measured by full-time-equivalent positions) that lithotripsy procedures represent relative to all types of direct care provided by the center. This percentage is then applied to the center’s total administrative costs to arrive at the portion to be allocated to lithotripsy procedures. VA policy guidance does not stipulate how the calculation is to be made. We reviewed the center’s methods and found no reason to adjust their results. Under VA policy, the charge to be assessed for central office administration, Albuquerque center building depreciation, and investment interest is a designated percentage of the total costs for all other components. We reviewed the center’s methods and found no reason to adjust their results. We found the cost for this component to be understated, because the Albuquerque center had underestimated the total cost for the other components. Our computations of the other components produced a total of $2,966, which was $1,670 more than the amount the Albuquerque center had used. Applying the designated percentage to the higher total raised the amount for this component to $456, an increase of $224. We found that the per-procedure charge for this component was understated. Although VA had allocated the appropriate percentage of engineering and building maintenance costs to the lithotripsy function, these costs had again been divided by the estimate of 882 procedures, resulting in a per-procedure charge of $43. Dividing the costs by the 155 procedures actually performed yields a cost of $244—a net increase of $201. The Albuquerque center’s 1994 charge to UNM for basic lithotripsy services is $1,451. Two key assumptions in the center’s calculations make it unlikely that this rate will be sufficient for VA to recover the costs of providing lithotripsy services to UNM patients. The first assumption is the estimate of the number of procedures that will be performed. The center estimated the number as 500. As of June 30, 1994, however—halfway through the year—the center had performed 97 procedures. The second assumption is the length of time for recovering the lithotripter’s cost. The center used an approach that had the effect of extending the total period for recovering the cost to 9 years—4 years longer than the period used for the 1993 estimate. This appendix compares the center’s estimated charges for the major cost components of its basic lithotripsy service to the amounts that would be chargeable, using different assumptions regarding workload and investment recovery period. Our assumed workload was 223 procedures rather than the 500 assumed by the Albuquerque center. The investment recovery period we used was the same period the center had used in its 1993 price determination. The Albuquerque center’s 1994 charge may be separated into two parts: a $658 charge for operating the lithotripter, and a $793 charge for facilities support. These charges will recover the center’s fixed and variable costs if 500 procedures or more are performed and the equipment is operated for 9 years or more. The center, however, will experience a significant shortfall if it performs less than half of the expected procedures, a situation that appears likely given the workload generated during the first half of 1994. As the following sections show, most of the shortfall will be related to the center’s charge for operating the lithotripter and only a small portion will be attributable to its facilities support charge. Under the assumptions we used, the Albuquerque center’s charge for its lithotripter and technician would be $2,168 rather than the $658 charged. Most of the difference relates to the depreciation charge. Table VI.1 separates the differences by the specific cost components included in the charge. VA’s calculations for staffing were not affected by its estimate of the number of procedures that would be performed in 1994. This is because staffing costs are assessed on a procedure-by-procedure basis, not on estimated workload. This component resulted in the largest difference between the center’s calculation and ours—$357 as set by the center, and $1,686 as we calculated it, a difference of $1,329. Two main factors contributed. One was the methodology the center used for changing the lithotripter’s useful life. The other was the estimated number of lithotripsy procedures over which the 1994 depreciation amount could be spread. In determining the annual amount of depreciation for the pricing computation, the center made two adjustments to its 1993 procedures.First, it used the acquisition price of the equipment rather than the amount that had been obligated to purchase the equipment. As we pointed out in appendix V, this was the more appropriate figure to use as a starting point. Second, it changed the lithotripter’s useful life from 5 years to 9 years. VA policy does not provide guidance for developing a change in the estimated useful life of equipment, but general accounting procedure does. The method to be used is as follows: when a change in estimated useful life is determined to be necessary, the remaining value of the asset, less any salvage value assigned, is to be divided by the remaining estimated life. The center did not follow this approach. Instead, it based its calculation on the full value of the asset (its original acquisition cost) and divided by the remaining 7 years of the 9-year useful life. In so doing, the center determined that an annual depreciation cost of $178,318 over 7 years would recover the initial acquisition costs of $1,248,225. Given the center’s estimated annual workload of 500 procedures, officials determined that a charge of $357 would be sufficient to realize the annual depreciation cost. The effect of this approach was to overstate the portion of the lithotripter’s cost to be depreciated each year, as well as the resulting charge per procedure. Because the center’s lithotripter had been operational for 2 years, and 295 procedures had been performed since that date, the center should have recognized an accumulated depreciation of $120,360, based on the $408 depreciation amount per procedure in the original rate (see table V.1). By adjusting the initial acquisition costs to reflect this accumulated depreciation, the remaining value of the lithotripter would be $1,127,865, which represents the amount to be depreciated over the remaining useful life. This approach would have yielded a depreciation charge of $322 per procedure over the center’s estimated workload of 500 procedures. By ignoring the accumulated depreciation, the center would recover more than the cost of the asset over its useful life. For example, if 500 procedures are performed for each of the next 7 years, the center would have a total recognized depreciation of $120,360 more than the $1,248,225 purchase price. Our recalculation of the amount to be depreciated is based on a 5-year useful life rather than a 9-year life. We used this shorter period in order to remain more consistent with the center’s previous methodology for determining costs and because we regard 5 years as a more appropriate period for recovering costs on equipment that can quickly become technologically obsolete even though it is still operable. Since 2 years of the period have gone by, 3 years remain over which to depreciate the equipment. We adjusted the purchase price by the $120,360 in accumulated depreciation and divided the remaining balance by the remaining 3 years to obtain an annual amount of depreciation of $375,955. This compares with the center’s computation of $178,318 in depreciation to be recovered during 1994. The other adjustment we made was to divide our annual depreciation amount by an estimate of 223 procedures to be performed during the year. The center had divided its annual depreciation amount by its estimate of 500 procedures. The combination of all of these adjustments produced our per-procedure recalculation amount of $1,686. This cost component covers the contract with the manufacturer for service and repair of the lithotripter and associated component parts. The center used the actual annual contract cost, as did we. The difference between the center’s price and our recalculation is again the number of procedures over which the cost is spread—the center used 500, and we used 223. This results in a difference of $181 per procedure. Under the assumptions we used, the Albuquerque center’s charge for facilities support and anesthesiology would be $1,103 rather than the $793 charged. This difference relates solely to the allocation of costs for administration and engineering and building management, as table VI.2 shows. Because staffing and supply costs are calculated on a per-procedure basis, they are unaffected by the different assumptions regarding workload and investment recovery period. As appendix V explained, this component is composed of several types of costs besides the administrative costs of VA’s headquarters in Washington, D.C., and is based on a percentage computed at the local level and applied to all other costs. We found the cost for this component to be understated, because the problems previously discussed for other cost components had produced a total for the other costs that was lower than it should have been. Applying the designated percentage to the higher total raised the amount for this component to $445, an increase of $216. This cost component allocates a prescribed percentage of engineering and building maintenance costs to the lithotripsy services. The difference between the center’s charge and our recalculation is the number of procedures over which the cost is spread—the center used 500, and we used 223. This results in a difference of $94 per procedure. The first copy of each GAO report and testimony is free. Additional copies are $2 each. 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Summary: Pursuant to a congressional request, GAO reviewed the Department of Veterans Affairs' (VA) Albuquerque Medical Center's contracting practices, focusing on: (1) whether the center fully recovered the government's cost of providing nonveteran lithotripsy services; and (2) the effects of the center's pricing policy on competition for lithotripsy services in the Albuquerque area. GAO found that: (1) in 1993, the Albuquerque VA Medical Center did not fully recover the costs of providing lithotripsy services to nonveterans; (2) the center used an unrealistically high annual workload estimate in calculating its fixed costs; (3) the center's lithotripsy prices for 1994 were still unrealistically high, even though VA policy requires price adjustments if estimates are significantly off; (4) the center lengthened the equipment's depreciation period to compensate for its low procedure rate, but this was not practical, since the equipment will be obsolete before the end of its useful life; (5) the contractor lowered its charges for lithotripsy services significantly below market rates, which may have allowed it to gain a larger market share; (6) the impact of the contractor's lower prices is difficult to estimate because consumers' health care decisions are not driven by cost considerations alone; and (7) the center could raise its prices to cover its full costs for the services and still remain competitive.