SECTION: CAPITOL HILL HEARING TESTIMONY

LENGTH: 6928 words

COMMITTEE: HOUSE WAYS AND MEANS

SUBCOMMITTEE: HEALTH

HEADLINE: MEDICARE DRUG PRICING MECHANISM

TESTIMONY-BY: HON. THOMAS A. SCULLY, ADMINISTRATOR,

AFFILIATION: CENTERS FOR MEDICARE & MEDICAID SERVICES

BODY:
CORRECTED COPY

Statement of the Hon. Thomas A. Scully, Administrator, Centers for Medicare & Medicaid Services

Testimony Before the Subcommittee on Health of the House Ways and Means Committee

Hearing on Medicare Payments for Currently Covered Prescription Drugs

October 3, 2002

Chairman Johnson, Congressman Stark, distinguished Subcommittee members, thank you for inviting me to discuss Medicare Part B reimbursement for prescription drugs. As you know, prescription drugs have become an increasingly important component of modern health care, particularly for Medicare beneficiaries. The President has taken a number of steps to provide immediate relief to America's seniors and people with disabilities who have high drug spending, and we are continuing to work closely with Congress to strengthen Medicare by including a comprehensive prescription drug benefit. I would like to thank you for your hard work on creating prescription drug legislation. Although we are disappointed that Medicare beneficiaries still do not have comprehensive drug coverage, we remain hopeful that we can continue to work together to enact this crucial benefit as soon as possible. It is also critically important that we improve the payment system for the small number of outpatient drugs currently covered by Medicare. It is clear that Medicare's payment system for those covered drugs, based on average wholesale price, or "AWP," is seriously flawed. The Medicare program relies on the prices reported by drug manufacturers to set payment rates. We all agree that Medicare should pay appropriately for all the services and treatments covered by Medicare, including the limited drugs that we currently cover. At the same time, we need to be certain that Medicare pays physicians and other providers appropriately for their services when they furnish drugs to beneficiaries. We support fair, competitive payments for Medicare prescription drugs. We understand that the Committee is working on such a proposal and we look forward to working with you.

By law, Medicare does not pay for most outpatient prescription drugs. However, there are some specific exceptions where Medicare covers pharmaceuticals, such as those drugs that are not self- administered and are furnished incident to a physician's covered services. In these cases, the law requires that Medicare pay physicians and other providers based on the lower of the billed charge or 95 percent of the drugs' AWP. Numerous studies have indicated that the industry's reported wholesale prices, the data on which Medicare bases its drug payments, are vastly higher than the prices drug manufacturers and wholesalers actually charge physicians and providers. That means Medicare beneficiaries, through their premiums and cost sharing, and U.S. taxpayers are spending far more than the "average" price that we believe the law intended them to pay for these drugs. Some affected physicians and providers have suggested that these Medicare "drug profits" are necessary to cross subsidize what they believe are inadequate Medicare payments for services related to furnishing the drugs, such as the administration of chemotherapy for cancer. We believe that finding a way to pay appropriately for both the drugs and the services related to furnishing those drugs is a better approach.

Clearly, Medicare drug pricing is complex. Over the years, numerous legislative efforts have made progress toward developing an effective alternative to AWP. These efforts have aimed at ensuring that Medicare and its beneficiaries do not pay more than they should for the prescription drugs that Medicare covers, and that physicians and providers are compensated appropriately for their services. We continue to believe that a legislative remedy to this problem would be preferable, and we will work with Congress to implement effective legislation. However, if necessary, we are prepared to build on the strong evidence and best ideas for reform developed in Congress by taking action under the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA), which provided some authority for the Secretary to act after reviewing the General Accounting Office (GAO) report to Congress. Under BIPA, we could move to a market-based system for drugs and adjust payments for services related to furnishing drugs such as practice expenses for oncology administration. As we look to the future, particularly as we add broader prescription drug coverage to Medicare, it is vital that we develop market-based, competitive pricing systems for drugs so that we do not repeat the past mistakes of overpayment. We are committed to working with Congress to amend the current system to make sure that Medicare pays a fair, competitive price for all benefits, including the limited drugs the program now covers.

MEDICARE'S LIMITED DRUG BENEFIT

The Centers for Medicare & Medicaid Services (CMS) pays most of the health care expenses of almost 40 million Medicare beneficiaries. If Congress were creating the Medicare program today, we believe it would certainly include a prescription drug benefit. When the Medicare program was enacted in 1965, however, prescription drugs played a less prominent role in health care than they do today. Although by law Medicare does not generally cover over-the-counter or outpatient prescription drugs, Medicare does cover some drugs, including:

* Drugs that are not self-administered and furnished "incident to" a physician's service, such as prostate cancer drugs; * Certain self-administered oral cancer and anti-nausea drugs; * Certain drugs used in conjunction with certain durable medical equipment or infusion devices, (e.g., the albuterol that is put into nebulizers, which are devices used by asthma patients); * Immunosuppressive drugs, which are used subsequent to organ transplants; * Clotting factors for beneficiaries with hemophilia; * Erythropoietin, the drug that constitutes Medicare's largest drug expenditure, is used primarily to treat anemia in end stage renal disease patients and in cancer patients; and * Osteoporosis drugs furnished to certain beneficiaries by home health agencies.

These drugs are typically provided in hospital outpatient settings, dialysis centers, or doctors' offices, and are purchased directly by the physician or physicians and providers. Generally, Medicare does not cover preventive drugs such as vaccines. However, Medicare law provides coverage specifically for certain vaccines, namely influenza, pneumonia, and hepatitis.

By law, Medicare carriers generally pay for these drugs based on either the actual charge or 95 percent of the AWP, whichever is lower. This adds up to more than $5 billion a year for currently covered drugs, approximately 80 percent of which is paid by the Medicare Trust Funds. In general, Medicare beneficiaries must also share in the cost of purchasing these drugs, except for the flu and pneumonia vaccines, through their Part B premiums, the $100 Part B annual deductible, and a 20 percent coinsurance.

MEDICARE PAYMENT FOR CURRENTLY COVERED DRUGS

The AWP is intended to represent the average price at which wholesalers sell drugs to their customers, which include physicians and pharmacies. Traditionally, AWP has been based on prices that are reported by drug manufacturers and printed in compendia such as the Red Book, published by Medical Economics Company, Inc. However, manufacturers and wholesalers are routinely offering physicians and providers competitive discounts that reduce the actual amount the physician or physicians and providers pays for the drugs. These discounts are not reflected in the published price and reduce the amount many physicians and providers actually pay to levels far below those prices published in the Red Book. However, Medicare's regulated payment system is tied to the published price of the drugs, precluding the program from obtaining competitive discounts for the drugs it covers. In addition, use of the AWP, as reported by manufacturers to companies that compile such prices, creates a situation where a manufacturer can, for certain drugs, arbitrarily increase the reported AWP and, in turn, offer physicians a deeper "discount." Furthermore, the deep competitive discounts, compared to the reported AWP, offered by drug manufacturers could give physicians and physicians and providers incentive to use a particular manufacturer's products for Medicare beneficiaries.

To give an example, a recent General Accounting Office report found that Medicare payments in 2001 for Part B-covered outpatient drugs were often much higher than the prices paid by physicians and pharmacy providers. The GAO reported that discounts of 13 to 34 percent off AWP were widely available for many physician-administered drugs. GAO also noted that two other physician-administered drugs had discounts of 65-86 percent.

This Committee, CMS, the Department's Office of the Inspector General (IG), and others have long recognized the shortcomings of using AWP as the basis for Medicare drug reimbursement. The IG has published numerous reports showing that true competitive market prices for the top drugs billed to the Medicare program by physicians, independent dialysis facilities, and durable medical equipment suppliers were actually significantly less than the AWP reported in the Red Book and other similar publications. As competitive discounts have become widespread, the AWP mechanism has resulted in increasing payment distortions. However, Medicare has continued to pay for these drugs based on the reported AWP (less 5 percent). It is simply unacceptable for Medicare to continue paying for drugs in an outdated, noncompetitive way that costs beneficiaries and the program far more than it should.

In the past, the Agency has attempted to remedy disparities between Medicare payments based on AWP and the amount actually paid by physicians and providers. However, these efforts have been unsuccessful. For example, the Agency's proposed June 1991 physician fee schedule included payments based on 85 percent of AWP. The Agency also proposed that certain high volume drugs be reimbursed at levels equal to either the lesser of 85 percent of AWP or the physicians' and providers' estimated acquisition cost. The Agency received many comments, primarily from oncologists, indicating that an 85 percent standard was inappropriate. Most comments indicated that while many drugs could be purchased for less than 85 percent of AWP, other drugs were not discounted. Other comments suggested that while pharmacies and perhaps large practices could receive substantial discounts on their drug prices, individual physicians could not. As an alternative, beginning with 1992, the Agency established a policy for Medicare to pay either the AWP or the estimated acquisition cost, whichever was less.

Since the estimated acquisition cost approach proved to be unworkable, subsequent legislation was proposed that would have required Medicare to pay physicians their actual acquisition cost for drugs. Under this proposal, physicians would tell Medicare what they paid for the drugs and be reimbursed that amount, rather than the Agency developing an estimate of acquisition costs and paying physicians based on that estimate. After considering this proposal, Congress adopted an alternative approach in the Balanced Budget Act of 1997 (BBA), setting Medicare's payment for drugs at the lesser of the billed charge or 95 percent of AWP. While this brought Medicare payments closer to the prices that physicians and providers pay for drugs, Medicare payments for many drugs were still significantly greater than the competitive discounts obtained by physicians. The system still tied Medicare payments to the artificially inflated industry-reported list prices. In fact, in a December 1997 report, the IG found payments based on AWP to be substantially greater than the prices available to the physician community. As an alternative to actual acquisition costs, Congress considered proposals to pay all Medicare drugs at 83 percent of AWP, a compromise between 95 percent of the AWP and the average discount found by the IG.

In May 2000, the Department of Justice (DOJ) and the National Association of Medicaid Fraud Control Units made advertised market wholesale prices for 49 drugs covered by Medicaid available to State Medicaid programs and to First Data Bank, a drug price compendium owned by the Hearst Corporation. These wholesale prices, culled from wholesale catalogs circulated among the physician and provider community, while not reflecting certain other discounts such as rebates, were closer to the actual average wholesale prices for these drugs than the drug manufacturers' reported AWP. In 2000, the Agency sent this new information to Medicare carriers and instructed them to consider these alternative wholesale prices as another source of AWP data in determining their January 1, 2001, quarterly update for many of these drugs. Due to concerns about Medicare reimbursement for the administration of the chemotherapy and clotting factor drugs, the Administration instructed our carriers not to use the data for those drugs at that time. Anticipating Congressional action that was soon enacted in BIPA, establishing a moratorium on decreases in Medicare drug reimbursement rates, the Agency in December 2000 postponed Medicare carriers' use of the DOJ data while the GAO conducted a study of Medicare drug pricing and related payment issues. BIPA also provided some authority for the Secretary to address AWP after reviewing the GAO's findings.

FLAWS IN AWP THAT AFFECT THE OUTPATIENT RULE

The shortcomings that I've discussed today regarding AWP also affect payment in the outpatient prospective payment system (OPPS). More specifically, it has affected perceptions about the updated payments for OPPS for 2003. In 2000, CMS adopted a prospective payment system for outpatient services delivered by hospitals, which includes the drugs and devices used in a procedure. By law, payments must be based on the relative cost of treatment. The law further requires that CMS must make additional payments, called "pass-through payments," for new drugs and devices. These payments are allowed for two to three years and, for drugs, are calculated to be the difference between the amount in the rate for existing products and the average wholesale price for the new product. The total dollars set aside for these new drugs and devices currently is limited to 2.5 percent of total spending for services under the outpatient prospective payment system. By law, CMS must use AWPs as reported by the manufacturer for these drugs to set payment rates for these drugs and to calculate the amount funded out of the pass-through pool. Using AWPs that overstate the costs of some drugs results in higher "pass-through payments" and makes less money available for other items eligible for pass-through payments.

In 2003, as a result of collection and analysis of nearly 60 million actual hospital claims, we have been able to set payment rates more accurately. As the payments for some procedures go up, payments for other ones go down and vice versa. However, a recent New York Times article misrepresented the impact on payments to hospital outpatient departments. Although payments for many items will be lower in 2003, overall Medicare payments to outpatient departments are projected to increase by almost 8 percent, reflecting hospitals' estimated acquisition costs rather than manufacturers' reported wholesale prices for prescription drugs. While proposed rates for many drugs are lower than 2002 rates, 2002 rates were likely greatly overstated in many cases because they were based on overinflated manufacturers' AWPs.

The story is similar with respect to our payments for procedures using pass-through devices. For 2002 rates we used prices reported by manufacturers to set payment rates for these types of procedures. The other hospital costs for the procedure, such as the operating room, supplies, and nursing time, were calculated using the latest available charges from approximately 50 million hospital claims and the latest available cost reports. I'd like to discuss a couple of examples of how payment rates have changed over the past several years for procedures that use pass-through devices. In my first example, payment for the insertion of a cardioverter-defibrillator, a hospital in 2001 received $7,411 for the procedure plus an additional amount for pass-through devices used during the procedure. The additional payment amount for pass-through devices was equal to the hospital's charges for the device(s) reduced to costs using the latest available hospital's cost-to-charge ratio (CCR). For 2002, the estimated cost of the procedure was about $1,500. Using claims and cost report information from hospitals, we would have added another $6,800 for device costs and the total payment would have been about $8,300. However, because we folded in an additional amount based on prices submitted to us by manufacturers, we added another $11,100 to the payment - bringing the total device- related costs to $17,900. Thus, in 2002, a hospital receives about $19,400 plus an additional amount in pass-through payments. For 2003, we have determined that the total payment for the procedure should be about $9,400. This payment reflects the cost of the procedure ( $1,550) plus the estimated cost of devices used with the procedure ( $7,850). Because pass-through eligibility for the devices that are being used with this procedure will expire January 1, 2003, we have fully incorporated their estimated costs, using hospital claims and the latest available cost reports, into the costs of the procedure. Similarly in my second example, the implantation of a drug infusion device, a hospital in 2001 received $561 plus an additional amount for pass-through devices used during the procedure. The additional payment amount for pass-through devices was equal to the hospital's charges for the device(s) reduced to costs using the latest available hospital's cost-to-charge ratios (CCR).

For 2002, the estimated cost of the procedure was about $940. Using claims information from hospitals we would have added another $3,800 for device costs and the total payment would have been about $4,750. However, because of the fold-in based manufacturers' reported prices, we added another $2,400 to the payment - bringing the total device-related costs to $6,200. Thus in 2002 a hospital receives about $7,150 plus an additional amount in pass-through payments.

As noted in the proposed rule, we estimate that the total payment for the procedure for 2003 should be about $6,660. This payment reflects the estimated cost of the procedure ($1,640) plus the estimated cost of devices used with the procedure ($5,020). Because pass-through eligibility for the devices that are being used with this procedure will expire January 1, 2003, we have fully incorporated their estimated costs into the procedure.

To the extent that CMS has to overpay for devices, payments for and access to other services for all beneficiaries are reduced. For example, between 2001 and 2002, payment for diagnostic mammography fell 13 percent. Under the proposed 2003 rates, the rationalization of payment for many devices has helped to allow for an 18% increase in diagnostic mammography payments. In the end, from 2000 to 2003, payment rates for most procedures using pass-through devices will have increased steadily and significantly. We shouldn't be allowing artificial prices nor artificial AWPs to undercut access to basic, preventive, and other services for beneficiaries.

CONCLUSION

Medicare beneficiaries rely on prescription drugs to treat a wide variety of chronic and acute conditions. For many seniors, in the traditional fee-for-service plan, the coinsurance that they pay is tied to Medicare's payment rate. We must find a fair way to make sure that Medicare beneficiaries and taxpayers do not pay excessive prices for prescription drugs that are far above the competitive discounts that are widely available today to other Americans. We need to pay appropriately for all Medicare benefits, including the prescription drugs we do cover and the services required to furnish those drugs. We look forward to working with you Mrs. Chairman, this Committee, and the Congress to implement improvements in Medicare's payment policy for currently covered drugs. Thank you for the opportunity to discuss this important topic with you today, and I am happy to answer your questions.

Statement of the Hon. Thomas A. Scully, Administrator, Centers for Medicare & Medicaid Services

Testimony Before the Subcommittee on Health of the House Committee on Ways and Means

Hearing on Medicare Payments for Currently Covered Prescription Drugs

October 3, 2002

Chairman Johnson, Congressman Stark, distinguished Subcommittee members, thank you for inviting me to discuss Medicare Part B reimbursement for prescription drugs. As you know, prescription drugs have become an increasingly important component of modern health care, particularly for Medicare beneficiaries. The President has taken a number of steps to provide immediate relief to America's seniors and people with disabilities who have high drug spending, and we are continuing to work closely with Congress to strengthen Medicare by including a comprehensive prescription drug benefit. I would like to thank you for your hard work on creating prescription drug legislation. Although we are disappointed that Medicare beneficiaries still do not have comprehensive drug coverage, we remain hopeful that we can continue to work together to enact this crucial benefit as soon as possible.

It is also critically important that we improve the payment system for the small number of outpatient drugs currently covered by Medicare. It is clear that Medicare's payment system for those covered drugs, based on average wholesale price, or "AWP," is seriously flawed. The Medicare program relies on the prices reported by drug manufacturers to set payment rates. We all agree that Medicare should pay appropriately for all the services and treatments covered by Medicare, including the limited drugs that we currently cover. At the same time, we need to be certain that Medicare pays physicians and other providers appropriately for their services when they furnish drugs to beneficiaries. We support fair, competitive payments for Medicare prescription drugs. We understand that the Committee is working on such a proposal and we look forward to working with you.

By law, Medicare does not pay for most outpatient prescription drugs. However, there are some specific exceptions where Medicare covers pharmaceuticals, such as those drugs that are not self- administered and are furnished incident to a physician's covered services. In these cases, the law requires that Medicare pay physicians and other providers based on the lower of the billed charge or 95 percent of the drugs' AWP. Numerous studies have indicated that the industry's reported wholesale prices, the data on which Medicare bases its drug payments, are vastly higher than the prices drug manufacturers and wholesalers actually charge physicians and providers. That means Medicare beneficiaries, through their premiums and cost sharing, and U.S. taxpayers are spending far more than the "average" price that we believe the law intended them to pay for these drugs. Some affected physicians and providers have suggested that these Medicare "drug profits" are necessary to cross subsidize what they believe are inadequate Medicare payments for services related to furnishing the drugs, such as the administration of chemotherapy for cancer. We believe that finding a way to pay appropriately for both the drugs and the services related to furnishing those drugs is a better approach.

Clearly, Medicare drug pricing is complex. Over the years, numerous legislative efforts have made progress toward developing an effective alternative to AWP. These efforts have aimed at ensuring that Medicare and its beneficiaries do not pay more than they should for the prescription drugs that Medicare covers, and that physicians and providers are compensated appropriately for their services. We continue to believe that a legislative remedy to this problem would be preferable, and we will work with Congress to implement effective legislation. However, if necessary, we are prepared to build on the strong evidence and best ideas for reform developed in Congress by taking action under the Medicare, Medicaid, and SCHIP Benefits Improvement and Protection Act of 2000 (BIPA), which provided some authority for the Secretary to act after reviewing the General Accounting Office (GAO) report to Congress. Under BIPA, we could move to a market-based system for drugs and adjust payments for services related to furnishing drugs such as practice expenses for oncology administration. As we look to the future, particularly as we add broader prescription drug coverage to Medicare, it is vital that we develop market-based, competitive pricing systems for drugs so that we do not repeat the past mistakes of overpayment. We are committed to working with Congress to amend the current system to make sure that Medicare pays a fair, competitive price for all benefits, including the limited drugs the program now covers.

MEDICARE'S LIMITED DRUG BENEFIT

The Centers for Medicare & Medicaid Services (CMS) pays most of the health care expenses of almost 40 million Medicare beneficiaries. If Congress were creating the Medicare program today, we believe it would certainly include a prescription drug benefit. When the Medicare program was enacted in 1965, however, prescription drugs played a less prominent role in health care than they do today. Although by law Medicare does not generally cover over-the-counter or outpatient prescription drugs, Medicare does cover some drugs, including:

* Drugs that are not self-administered and furnished "incident to" a physician's service, such as prostate cancer drugs; * Certain self-administered oral cancer and anti-nausea drugs; * Certain drugs used in conjunction with certain durable medical equipment or infusion devices, (e.g., the albuterol that is put into nebulizers, which are devices used by asthma patients); * Immunosuppressive drugs, which are used subsequent to organ transplants; * Clotting factors for beneficiaries with hemophilia; * Erythropoietin, the drug that constitutes Medicare's largest drug expenditure, is used primarily to treat anemia in end stage renal disease patients and in cancer patients; and * Osteoporosis drugs furnished to certain beneficiaries by home health agencies.

These drugs are typically provided in hospital outpatient settings, dialysis centers, or doctors' offices, and are purchased directly by the physician or physicians and providers. Generally, Medicare does not cover preventive drugs such as vaccines. However, Medicare law provides coverage specifically for certain vaccines, namely influenza, pneumonia, and hepatitis.

By law, Medicare carriers generally pay for these drugs based on either the actual charge or 95 percent of the AWP, whichever is lower. This adds up to more than $5 billion a year for currently covered drugs, approximately 80 percent of which is paid by the Medicare Trust Funds. In general, Medicare beneficiaries must also share in the cost of purchasing these drugs, except for the flu and pneumonia vaccines, through their Part B premiums, the $100 Part B annual deductible, and a 20 percent coinsurance.

MEDICARE PAYMENT FOR CURRENTLY COVERED DRUGS

The AWP is intended to represent the average price at which wholesalers sell drugs to their customers, which include physicians and pharmacies. Traditionally, AWP has been based on prices that are reported by drug manufacturers and printed in compendia such as the Red Book, published by Medical Economics Company, Inc. However, manufacturers and wholesalers are routinely offering physicians and providers competitive discounts that reduce the actual amount the physician or physicians and providers pays for the drugs. These discounts are not reflected in the published price and reduce the amount many physicians and providers actually pay to levels far below those prices published in the Red Book. However, Medicare's regulated payment system is tied to the published price of the drugs, precluding the program from obtaining competitive discounts for the drugs it covers. In addition, use of the AWP, as reported by manufacturers to companies that compile such prices, creates a situation where a manufacturer can, for certain drugs, arbitrarily increase the reported AWP and, in turn, offer physicians a deeper "discount." Furthermore, the deep competitive discounts, compared to the reported AWP, offered by drug manufacturers could give physicians and physicians and providers incentive to use a particular manufacturer's products for Medicare beneficiaries.

To give an example, a recent General Accounting Office report found that Medicare payments in 2001 for Part B-covered outpatient drugs were often much higher than the prices paid by physicians and pharmacy providers. The GAO reported that discounts of 13 to 34 percent off AWP were widely available for many physician-administered drugs. GAO also noted that two other physician-administered drugs had discounts of 65-86 percent.

This Committee, CMS, the Department's Office of the Inspector General (IG), and others have long recognized the shortcomings of using AWP as the basis for Medicare drug reimbursement. The IG has published numerous reports showing that true competitive market prices for the top drugs billed to the Medicare program by physicians, independent dialysis facilities, and durable medical equipment suppliers were actually significantly less than the AWP reported in the Red Book and other similar publications. As competitive discounts have become widespread, the AWP mechanism has resulted in increasing payment distortions. However, Medicare has continued to pay for these drugs based on the reported AWP (less 5 percent). It is simply unacceptable for Medicare to continue paying for drugs in an outdated, noncompetitive way that costs beneficiaries and the program far more than it should.

In the past, the Agency has attempted to remedy disparities between Medicare payments based on AWP and the amount actually paid by physicians and providers. However, these efforts have been unsuccessful. For example, the Agency's proposed June 1991 physician fee schedule included payments based on 85 percent of AWP. The Agency also proposed that certain high volume drugs be reimbursed at levels equal to either the lesser of 85 percent of AWP or the physicians' and providers' estimated acquisition cost. The Agency received many comments, primarily from oncologists, indicating that an 85 percent standard was inappropriate. Most comments indicated that while many drugs could be purchased for less than 85 percent of AWP, other drugs were not discounted. Other comments suggested that while pharmacies and perhaps large practices could receive substantial discounts on their drug prices, individual physicians could not. As an alternative, beginning with 1992, the Agency established a policy for Medicare to pay either the AWP or the estimated acquisition cost, whichever was less.

Since the estimated acquisition cost approach proved to be unworkable, subsequent legislation was proposed that would have required Medicare to pay physicians their actual acquisition cost for drugs. Under this proposal, physicians would tell Medicare what they paid for the drugs and be reimbursed that amount, rather than the Agency developing an estimate of acquisition costs and paying physicians based on that estimate. After considering this proposal, Congress adopted an alternative approach in the Balanced Budget Act of 1997 (BBA), setting Medicare's payment for drugs at the lesser of the billed charge or 95 percent of AWP. While this brought Medicare payments closer to the prices that physicians and providers pay for drugs, Medicare payments for many drugs were still significantly greater than the competitive discounts obtained by physicians. The system still tied Medicare payments to the artificially inflated industry-reported list prices. In fact, in a December 1997 report, the IG found payments based on AWP to be substantially greater than the prices available to the physician community. As an alternative to actual acquisition costs, Congress considered proposals to pay all Medicare drugs at 83 percent of AWP, a compromise between 95 percent of the AWP and the average discount found by the IG.

In May 2000, the Department of Justice (DOJ) and the National Association of Medicaid Fraud Control Units made advertised market wholesale prices for 49 drugs covered by Medicaid available to State Medicaid programs and to First Data Bank, a drug price compendium owned by the Hearst Corporation. These wholesale prices, culled from wholesale catalogs circulated among the physician and provider community, while not reflecting certain other discounts such as rebates, were closer to the actual average wholesale prices for these drugs than the drug manufacturers' reported AWP. In 2000, the Agency sent this new information to Medicare carriers and instructed them to consider these alternative wholesale prices as another source of AWP data in determining their January 1, 2001, quarterly update for many of these drugs. Due to concerns about Medicare reimbursement for the administration of the chemotherapy and clotting factor drugs, the Administration instructed our carriers not to use the data for those drugs at that time. Anticipating Congressional action that was soon enacted in BIPA, establishing a moratorium on decreases in Medicare drug reimbursement rates, the Agency in December 2000 postponed Medicare carriers' use of the DOJ data while the GAO conducted a study of Medicare drug pricing and related payment issues. BIPA also provided some authority for the Secretary to address AWP after reviewing the GAO's findings.

FLAWS IN AWP THAT AFFECT THE OUTPATIENT RULE

The shortcomings that I've discussed today regarding AWP also affect payment in the outpatient prospective payment system (OPPS). More specifically, it has affected perceptions about the updated payments for OPPS for 2003. In 2000, CMS adopted a prospective payment system for outpatient services delivered by hospitals, which includes the drugs and devices used in a procedure. By law, payments must be based on the relative cost of treatment. The law further requires that CMS must make additional payments, called "pass-through payments," for new drugs and devices. These payments are allowed for two to three years and, for drugs, are calculated to be the difference between the amount in the rate for existing products and the average wholesale price for the new product. The total dollars set aside for these new drugs and devices currently is limited to 2.5 percent of total spending for services under the outpatient prospective payment system. By law, CMS must use AWPs as reported by the manufacturer for these drugs to set payment rates for these drugs and to calculate the amount funded out of the pass-through pool. Using AWPs that overstate the costs of some drugs results in higher "pass-through payments" and makes less money available for other items eligible for pass-through payments.

In 2003, as a result of collection and analysis of nearly 60 million actual hospital claims, we have been able to set payment rates more accurately. As the payments for some procedures go up, payments for other ones go down and vice versa. However, a recent New York Times article misrepresented the impact on payments to hospital outpatient departments. Although payments for many items will be lower in 2003, overall Medicare payments to outpatient departments are projected to increase by almost 8 percent, reflecting hospitals' estimated acquisition costs rather than manufacturers' reported wholesale prices for prescription drugs. While proposed rates for many drugs are lower than 2002 rates, 2002 rates were likely greatly overstated in many cases because they were based on overinflated manufacturers' AWPs.

The story is similar with respect to our payments for procedures using pass-through devices. For 2002 rates we used prices reported by manufacturers to set payment rates for these types of procedures. The other hospital costs for the procedure, such as the operating room, supplies, and nursing time, were calculated using the latest available charges from approximately 50 million hospital claims and the latest available cost reports. I'd like to discuss a couple of examples of how payment rates have changed over the past several years for procedures that use pass-through devices. In my first example, payment for the insertion of a cardioverter-defibrillator, a hospital in 2001 received $7,411 for the procedure plus an additional amount for pass-through devices used during the procedure. The additional payment amount for pass-through devices was equal to the hospital's charges for the device(s) reduced to costs using the latest available hospital's cost-to-charge ratio (CCR). For 2002, the estimated cost of the procedure was about $1,500. Using claims and cost report information from hospitals, we would have added another $6,800 for device costs and the total payment would have been about $8,300. However, because we folded in an additional amount based on prices submitted to us by manufacturers, we added another $11,100 to the payment - bringing the total device- related costs to $17,900. Thus, in 2002, a hospital receives about $19,400 plus an additional amount in pass-through payments. For 2003, we have determined that the total payment for the procedure should be about $9,400. This payment reflects the cost of the procedure ( $1,550) plus the estimated cost of devices used with the procedure ( $7,850). Because pass-through eligibility for the devices that are being used with this procedure will expire January 1, 2003, we have fully incorporated their estimated costs, using hospital claims and the latest available cost reports, into the costs of the procedure. Similarly in my second example, the implantation of a drug infusion device, a hospital in 2001 received $561 plus an additional amount for pass-through devices used during the procedure. The additional payment amount for pass-through devices was equal to the hospital's charges for the device(s) reduced to costs using the latest available hospital's cost-to-charge ratios (CCR).

For 2002, the estimated cost of the procedure was about $940. Using claims information from hospitals we would have added another $3,800 for device costs and the total payment would have been about $4,750. However, because of the fold-in based manufacturers' reported prices, we added another $2,400 to the payment - bringing the total device-related costs to $6,200. Thus in 2002 a hospital receives about $7,150 plus an additional amount in pass-through payments.

As noted in the proposed rule, we estimate that the total payment for the procedure for 2003 should be about $6,660. This payment reflects the estimated cost of the procedure ($1,640) plus the estimated cost of devices used with the procedure ($5,020). Because pass-through eligibility for the devices that are being used with this procedure will expire January 1, 2003, we have fully incorporated their estimated costs into the procedure.

To the extent that CMS has to overpay for devices, payments for and access to other services for all beneficiaries are reduced. For example, between 2001 and 2002, payment for diagnostic mammography fell 13 percent. Under the proposed 2003 rates, the rationalization of payment for many devices has helped to allow for an 18% increase in diagnostic mammography payments. In the end, from 2000 to 2003, payment rates for most procedures using pass-through devices will have increased steadily and significantly. We shouldn't be allowing artificial prices nor artificial AWPs to undercut access to basic, preventive, and other services for beneficiaries.

CONCLUSION

Medicare beneficiaries rely on prescription drugs to treat a wide variety of chronic and acute conditions. For many seniors, in the traditional fee-for-service plan, the coinsurance that they pay is tied to Medicare's payment rate. We must find a fair way to make sure that Medicare beneficiaries and taxpayers do not pay excessive prices for prescription drugs that are far above the competitive discounts that are widely available today to other Americans. We need to pay appropriately for all Medicare benefits, including the prescription drugs we do cover and the services required to furnish those drugs. We look forward to working with you Mrs. Chairman, this Committee, and the Congress to implement improvements in Medicare's payment policy for currently covered drugs. Thank you for the opportunity to discuss this important topic with you today, and I am happy to answer your questions.

LOAD-DATE: October 4, 2002