FDA is responsible for regulating the marketing of medical devices to provide reasonable assurance of their safety and effectiveness for human use. As part of its regulatory responsibility, FDA reviews applications from manufacturers that wish to market their medical devices in the United States. Prior to marketing new devices, manufacturers must apply for FDA marketing approval through either the premarket notification (also referred to as 510(k)) process, or the premarket approval (PMA) process, a more rigorous regulatory review. New devices are subject to PMA, unless they are substantially equivalent to an already marketed device, in which case they need to comply only with the premarket notification requirements. Applications for premarket notification are generally reviewed more quickly than applications for PMA and do not usually require clinical data. Medical devices are regulated using a three-part classification system and are subject to different levels of control based upon their classifications as class I, II, or III devices. Class I devices are generally those with the lowest risk for use by humans and require the least regulatory oversight. These devices are subject to general controls, which include standards for good manufacturing practices, and requirements related to manufacturer registration, maintenance of records, and reporting. Examples of class I devices are patient examination gloves, canes, and crutches. Class II devices are generally of higher risk and are also subject to general controls; however, FDA can establish special controls for these devices, such as development and dissemination of guidance documents, mandatory performance standards, and postmarket surveillance. Examples of class II devices are blood glucose test systems and infusion pumps. Class III devices typically pose the greatest risk and thus have the highest level of regulation. This classification includes most devices that support or sustain human life, are of substantial importance in preventing impairment of human health, or present a potential unreasonable risk of illness or injury. Because general and special controls may not be sufficient to ensure safety and effectiveness, these devices, with limited exceptions, must obtain PMA. To obtain PMA, the manufacturer must provide FDA with sufficient valid scientific evidence providing reasonable assurance that the device is safe and effective for its intended use. Once approved, changes to the device affecting safety or effectiveness require the submission and approval of a supplement to its PMA. Examples of class III devices include automatic external defibrillators and implantable infusion pumps used to administer medication. Some class III devices are provided as part of a hospital visit; Medicare pays for these devices through the hospital inpatient or outpatient prospective payment systems. Five categories of class III devices, however, can be provided in physicians’ offices or prescribed by physicians for use in the home; Medicare pays for these devices through the DME fee schedule. In 2004, Medicare payments for class III devices under the DME fee schedule were $53.2 million, which represented less than 1 percent of total DME payments. The Medicare DME fee schedule payment rate for a device is based on either the manufacturer’s retail price or historic reasonable Medicare charges, which CMS considers equivalent measures. MMA provided for a 0 percent annual update for most Medicare DME fee schedule payment rates from 2004 through 2008. However, under MMA, class III devices were excluded from the 0 percent update and received payment updates equal to the annual percentage increase in the CPI-U in 2004, 2005, and 2006. For these devices, MMA provides, in 2007 for a payment update as determined by the Secretary of Health and Human Services, and in 2008, for a payment update equal to the annual percentage increase in the CPI-U. We found that with limited exceptions, manufacturers of class III devices have higher premarketing costs than do manufacturers of class II devices. Manufacturers of class III devices pay higher FDA user fees for review of their devices, because of the more complex FDA review required prior to marketing, than do manufacturers of class II devices. According to FDA data, compared to class II manufacturers, class III manufacturers have a longer period before approval during the FDA application process, which lengthens the time before they can market their devices and begin receiving revenue. FDA requires that manufacturers submit clinical data for class III devices, but only occasionally requires the same for class II devices. In addition, class III manufacturers stated they incur higher premarketing costs for other research and development than do manufacturers of class II devices. However, class II manufacturers also stated that they incur substantial premarketing costs related to other research and development. Because we did not evaluate proprietary data on other premarketing research and development costs, we could not determine whether a difference in other premarketing research and development costs exists between class III and class II manufacturers. Manufacturers of class III devices pay higher FDA user fees for review of their devices, because of the more complex FDA review required prior to marketing, than do manufacturers of class II devices. Specifically, manufacturers of class III devices subject to this review pay the FDA user fee for PMA, which in 2005 was $239,237 for each PMA. Most PMA supplements, which must be filed when a manufacturer makes a change to a class III device that affects its safety or effectiveness, also require payment of a fee, which ranged from $6,546 to $239,237. Manufacturers of class II devices pay the FDA user fee for each premarket notification, which in 2005 was $3,502. When a manufacturer makes a change to a class II device, a new premarket notification application must be filed; there is no supplement process for these devices. Manufacturers of class III devices have a longer period before approval during the FDA application process, which they stated delays the marketing of their devices and the receipt of revenue. According to ODE’s 2004 Annual Report, in 2004, the average time for PMA review was 503 days while the average time for premarket notification review was 100 days. These average times include the total time a PMA or premarket notification was under review by FDA and the time the manufacturer used in responding to any FDA requests for additional information. FDA requires that class III manufacturers submit clinical data, for which manufacturers incur costs. FDA only occasionally requires the submission of clinical data for class II devices. Specifically, FDA requires manufacturers of class III devices to submit clinical data as part of the PMA process to provide reasonable assurance that the devices are safe and effective for their intended uses. During its review of a device’s PMA application, FDA may require that the manufacturer provide additional information, which may require submission of additional clinical data. Manufacturers of class III devices stated that to collect clinical data, they conducted costly animal studies, human preclinical studies, and human clinical trials. Manufacturers of class II devices must satisfy premarket notification requirements; that is, they must submit documentation that a device is substantially equivalent to a legally marketed device. An FDA official stated that manufacturers of class II devices may be required to provide clinical data. They may be required to provide these data, for example, to demonstrate that modifications they have made to a device would not significantly affect its safety or effectiveness, or if a device is to be marketed for a new or different indication. According to FDA, 10 to 15 percent of premarket notification applications include clinical data. Manufacturers of class III devices we spoke with stated that in addition to collecting clinical data, they incur higher premarketing costs related to other research and development, such as labor costs and manufacturing supplies related to designing a device, than do manufacturers of other classes of devices. They stated that class III devices are highly innovative, complex products that require costly premarketing research and development to produce. One class III manufacturer we spoke with stated that approximately 10 percent of its revenue between 2002 and 2005 was invested in premarketing research and development. Another class III manufacturer stated that approximately 4 percent of its operating budget is spent on premarketing research and development. However, manufacturers of class II devices we spoke with also stated that they incur substantial premarketing costs related to research and development. Specifically, we spoke with a manufacturer of an insulin pump and two manufacturers of continuous positive airway pressure devices, each of which stated it incurs substantial research and development costs. One class II manufacturer stated that 10 to 15 percent of a device’s total cost was attributable to research and development. Another class II manufacturer stated that approximately 7 to 10 percent of its revenue is spent on research and development. Because we did not evaluate proprietary data for other premarketing research and development costs, we were unable to determine whether a difference in other premarketing research and development costs exists between class III and class II manufacturers. The CMS rate-setting methodology for Medicare’s DME fee schedule accounts for the premarketing costs of class II and class III devices in a consistent manner. The fee schedule payment rate for an item of DME, regardless of device classification, is based on either historic Medicare charges or the manufacturer’s retail price, which CMS has determined are equivalent measures. Manufacturers of both class II and class III devices we spoke with stated that when setting their retail prices, they take into account all premarketing costs necessary to bring the device to market. CMS has two DME fee schedule rate-setting methodologies: one method is for items that belong to a payment category covered by Medicare at the time the DME fee schedule was implemented in 1989, and one method is for items added to the DME fee schedule after 1989 that are not covered by an existing payment category. Regardless of its classification as a class I, II, or III device, the payment rate for an item of DME covered by Medicare when the DME fee schedule was implemented in 1989 is based on its average reasonable Medicare charge from July 1, 1986, through June 30, 1987, for some items, and July 1, 1986, through December 31, 1986, for other items (both referred to as the base year). Historically, these payment rates have been updated by a uniform, statutorily set, percentage, which is usually based on the annual percentage increase in the CPI-U.