Medicare: Problems Affecting HCFA's Ability to Set Appropriate Reimbursement Rates for Medical Equipment and Supplies

Published by the Government Accountability Office on 1997-06-17.

Below is a raw (and likely hideous) rendition of the original report. (PDF)

United States
General Accounting Office
Washington, D.C. 20548

Health, Education   and Human Sexvices Division

June 17, 1997

The Honorable Charles E. Grassley
Chairman, Special Committee on Aging
United States Senate

Subject: Medicare: Problems Affecting HCFA’s Abilitv to Set Anuronriate
         Reimbursement Rates for Medical Euuinment and Sunulies

Dear Mr. Chairman:

Medicare spent over $4.3 bilhon in 1996 for medical equipment and supplies,’
such as walkers, catheters, and glucose test strips for its beneficiaries.
Problems in setting payment rates, however, raise concerns about whether the
Health Care Financing Amon             (HCFA) paid too much for these items.
Our prior studies2 and a report by the Office of the Inspector General (OIQ3 in
the Department of Health and Human Services (HHS) have documented that
Medicare pays higher-than-market rates for some items. HCFA recognizes that
it pays too much for some medical equipment and supplies, as we have
reported, but believes a slow and cumbersome regulatory process for adjusting
Medicare’s payment rates severely hinders its efforts to address overpricing.

At your request, we are currently reviewing the underlying problems associated
with setting appropriate Medicare reimbursement rates for medical

‘This amount includes expenditures for prosthetics, orthotics, and
pharmaceutical drugs (such as nebulizer drugs) used in conjunction with
durable medical equipment as well as expenditures for medical equipment and
%ee Medicare: Excessive Pavments for Medical SutmIies Continue Desoite
Imnrovements (GAO/HEHS-95171, Aug. 8, 1995) and Medicare Soending:
Modern Management Strategies Needed to Curb Billions in Unnecessary
Pavments (GAOLEIEHS-95210, Sept. 19, 1995).

3Durable Medical Euuinment - Review of Medicare Pavments for Home Blood
Glucose Monitors, HHS OIG, A-09-92-00034 (Washington, DC.: Dec. 1992).
   GAOMEHS-97-16761Medicare Payments for Medical Equipment and Supplies

equipment and supplies. Because the Congress may shortly consider legislation
on Medicare payment rates, however, your office requested that we provide you
with interim information on the problems we have identified to date.
Specifically, this correspondence identifies two basic problems with the
Medicare reimbursement system for medical equipment and supplies: (1) HCFA
does not know specifically what products it is paying for when it pays claims
and (2) Medicare reimburses large suppliers and individual beneficiaries at the
same rates, even though those rates do not account for the discounts large
suppliers negotiate with manufacturers and wholesalers.

To develop our information, we analyzed Medicare payments for off-the-shelf,
commonly used medical equipment and supplies. We also reviewed the laws,
regulations, coding systems, and fee schedules for Medicare’s payments for
medical equipment and supplies. We obtained data on Medicare payments from
HCFA’s carriers and the statistical analysis contractor. We obtained
information on product pricing, distribution channels, and purchasing practices
through discussions with manufacturers, suppliers, and industry groups. We
also collected prices and acquisition costs for selected items from HCFA
contractors, various suppliers, wholesalers, manufacturers, a state Medicaid
agency, and the Department of Veterans Affairs.

Finally, we obtained information on universal product numbering systems for
medical products from the Department of Defense (DOD); associations
representing medical equipment suppliers, distributors, and manufacturers; and
a group of hospital buying groups, health care providers, manufacturers, and
distributors working on building a consensus for product idenacation

We performed our field work between March 1996 and June 1997 in accordance
with generally accepted government auditing standards, except for (1) auditing
the cost and pricing information obtained from suppliers and (2) examining the
internal and data processing controls of the Medicare claims databases
maintained by HCFA’s contractors. The cost and pricing information we
received from the multiple suppliers was fairly consistent In addition, the
statistical reports obtained from the Medicare claims databases were not critical
to our findings.


HCFA does not know specifically what products it is paying for when it pays
Medicare claims for medical equipment and supplies, according to our work to
date. HCFA does not require suppliers to identify specific products on their

2   GAOiEEHS-97-157R    Medicare   Payments   for Medical Equipment   and Supplies
Medicare claims. Instead, suppliers use HCFA billing codes, some of which
cover a broad range of products of various types, qualities, and market prices.
For example, suppliers use one Medicare billing code for more than 200
different urological catheters, even though some catheters sell at a fraction of
the price of others billed under the same code. Because Medicare pays
suppliers the same amount for all the products covered by a billing code, the
reimbursement system gives suppliers a financial incentive to provide Medicare
patients with the least costly products covered by a billing code. In addition,
because Medicare claims do not identify the specific product provided, HCFA
lacks the information it needs to ensure that each billing code is used for
comparable products.

To identify specific medical equipment and supplies, DOD and some other
major purchasers are beginning to require suppliers to use a universal product
numbering system This system, which can also be used for bar coding the
products, enables purchasers and insurers to identify specific products being
used and track reimbursements for each product and groups of similar products
as well as the market prices of specific products. HCFA officials, on the other
hand, have not begun exploring the possibility of using the universal product
numbering system in the Medicare program.

Medicare reimburses large supphers and individual beneficiaries the same
amounts for medical equipment and supplies, even though large suppliers
negotiate substantial discounts with manufacturers and wholesalers, while
individual beneficiaries pay retail prices. Large suppliers provide some
products, such as urological catheters and drainage bags, to nursing homes and
home health agencies, which then provide them to individual Medicare
beneficiaries. In turn, the large suppliers can bill Medicare directly and get
reimbursed at fee-schedule rates based on historicaI charges and catalog prices.
For example, one supplier’s weighted average cost for ah catheters billed in
1996 under one Medicare billing code was less than $1 per catheter; however,
Medicare reimbursed the supplier at the program’s feeschedule allowance of
$10 to $12 per catheter. HCFA has not considered establishing a separate fee
schedule for products provided to nursing home and home health patients that
accounts for their suppliers’ substantially lower acquisition costs compared with
the cost of products beneficiaries purchase directly.


Medicare covers a wide variety of medical equipment, such as walkers and
canes, and supplies such as urinary catheters, drainage bags, glucose test strips,

3   GAOBIEHS-97-15%     Medicare   Payments for Medical Equipment    and Supplies
and ostomy products4 Medicare part B insurance covers these products for
beneficiaries who live at home or in facilities used as homes, such as nursing
homes? Medicare pays 80 percent of the allowed amount, which is the lower of
the actual charge submitted by the supplier or the amount allowed under a fee
schedule. Medicare beneficiaries pay for the remaining 20 percent of the
allowed amount

HCFA classifies medical equipment and supplies into groups using the HCFA
Common Procedure Coding System (HCPCS). HCFA assigns each group of
products an HCPCScode intended to cover similar items, and all items covered
by a code are reimbursed at the same rate. When suppliers submit a Medicare
claim, they must specify an HCPCS code to identify the group that they believe
best describes the specific item provided to the Medicare patient.

Four HCFA contractors, called Durable Medical Equipment Regional Carriers
(hereafter referred to as carriers), process and pay Medicare claims for medical
equipment and supplies6 Each carrier covers a separate region of the country-
The Statktical Analysis Durable Medical Equipment Regional Carrier (referred
to as the statistical analysis contractor) analyzes claims processed by the
carriers and ensures that the carriers and suppliers uniformly interpret and use
the HCPCS codes7

Most Medicare part B payments for medical equipment and supplies are based
on a fee-schedule system set forth under section 1834 of the Social Security
Act8 Under this system, HCFA calculates a fee-schedule allowance for each
HCPCS code for each state. The allowances for each state are based on the
average historical charges that suppliers submitted in 1986 and 1981; the

4Medicare part A covers inpatient care in a hospital or skilled nursing facility
and home health or hospice care. Medicare part B covers physician services,
outpatient hospital services, durable medical equipment, and various other
health services.
5Medicare part I3 does not cover medical equipment and supplies for patients in
skilled nursing facilities whose stay is covered by part A.
%ese carriers are also known as DMERCs.
7The Statistical Analysis Durable Medical Equipment Regional Carrier is also
known as the SADMERC.
‘42 USC. 1395m.
4   GAO/HEHS-97-157R    Medicare   Paments   for Medical   Equipment   and Supplies
historical charges are indexed forward using the consumer price index. To
reduce variation among state payment rates, the state fees are subject to
national floors and ceilings. The national floor is 85 percent of the median of
all the state fees, and the ceiling is the median of all state fees for each billing
code. No state fee may exceed the national ceiling or be less than the national

For new medical equipment and supplies that do not match the description of
an HCPCS code, the carriers use a gap-filling process to establish
reimbursement rates. This process involves the carriers’ creating a product
price list by using the suggested retail prices found in catalogs. The fee-
schedule allowance is the lower of the average or the median suggested retail
prices found for products covered under the new HCPCS code.

HCFA recognizes that many of the Medicare fee-schedule allowances are now
out of line with current market prices because the fee-schedule allowances do
not reflect changes in technology and supplier costs. Some product prices may
have increased at rates lower or higher than the consumer price index, which
also forces the fee allowances out of line with market rates. HCFA is trying to
adjust some fee-schedule allowances, but the regulatory process mandated by
statute for making such adjustments is slow and cumbersome? For example,
aaustmg the Medicare allowance for home blood glucose monitors took HCFA
almost 3 years. For this reason, the administration is seeking legislative
authority to streamline the process by allowing the carriers to adjust the
Medicare allowances.


Suppliers who bill Medicare for medical products use billing codes that do not
identify the specif%zitems provided to beneficiaries. Because Medicare pays
one fee for ah products in a billing code, suppliers can furnish a low-cost item
to a Medicare beneficiary and get reimbursed at a rate that covers a higher cost
item billed under the same code. An official of the statistical analysis
contractor said that the billing system results in “winners” (suppliers who are
overpaid for lowcost items) and “losers” (suppliers who are underpaid for high-
cost items) and that the winners and losers likely balance out Because HCV-4
cannot track what items are being billed and provided, however, it does not

‘42 USC. 1395m(a) (10) (B).
5   GAOLHEHS-97-157R    Medicare   Payments   for Medical   Equipment   and Supplies
know to what extent suppliers are providing mostly low-cost items. Although
the health care industry is moving toward the use of universal product numbers
to more specifically identify medical equipment and supplies, HCFA has not
explored this approach for improving information on products Medicare pays

HCFA’s Coding Svstem Does Not Identi       Specific Products

HCFA’s coding system for medical equipment and supplies provides insufficient
information to identify the specific products suppliers provide to Medicare
beneficiaries. The HCPCS coding system used by HCFA classifies medical
equipment and supplies into general product groups, and, when suppliers bill
Medicare, they specify the HCPCS code they believe best describes the specific
equipment or supply item provided to a beneficiary. Suppliers and
manufacturers may also petition HCFA or the carriers to establish new HCPCS
codes for products they believe are not adequately described by or reimbursed
under the HCPCS codes.

Some HCPCS codes are used for products that differ widely in properties, uses,
and performance. Yet Medicare pays the same fee-schedule allowance (with
minor variations among states) for all products billed under the same HCPCS
code. For example, the HCPCS code for latex foley catheters”’ includes more
than 200 short-term, medium-term, and long-term catheters. According to one
manufacturer of foley catheters, specialized coatings affect the durability,
function, and price of these catheters. Wholesale prices of these catheters
range from $1.09 for a short-term catheter to $17.90 for a long-term catheter.
Medicare’s 1997 national floor and ceiling were $9.95 and $11.70, respectively,
for all catheters in this HCPCS code.

The fee-schedule system used in conjunction with the HCPCS codes provides a
financial incentive for suppliers to provide low-cost items to Medicare
beneficiaries, and these items may or may not meet the patient’s medical needs.
Suppliers can increase their profits by charging Medicare the full feeschedule
allowance for a lowcost product that technically fits the code description. For
example, although multiple types of latex foley catheters may be classified
under the same HCPCS code, information we gathered kom some suppliers
showed that the basic short-term catheter was both the least expensive and the

‘*A latex foley catheter is typically billed under HCPCS code A4338 (indwelling
catheter; foley type; two-way latex with coating, such as Teflon, silicone-coated,
silicone elastomer, or hydrophilic).
6   GAO/HEHS-97-157R    Medicare   Payments   for Medical   Equipment   and Supplies

most commonly provided catheter. HCFA cannot readiIy perform this type of
analysis because suppliers do not have to identify the specific products for
which they submit claims.

Industry groups and suppliers we contacted said they find the HCPCS coding
system difficult to use. Suppliers and manufacturers often need help in
deciding which HCPCS code is appropriate for specific products. In response,
the statistical analysis contractor has set up a hot line to handle coding
inquiries and medical policy and pricing questions; the hot line receives an
average of 8,000 calls a month. Coding inquiries account for about 80 percent
of the hot line’s monthly calls. Coding inquiries about the HCPCS codes for
ostomy and incontinence supplies are among the most prevalent

Product-Snecifrc Codes Are Available to Track Utilization

DOD and some hospital health care purchasing groups are beginning to require
their suppliers to use product-specific codes, caJled universal product numbers,
to identify individual medical products. This system requires manufacturers to
bar code each product to identify characteristics such as the manufacturer
identification number, product type, and packaging unit. Universal product
numbers will enable these government and private purchasers to develop
standard product groups, track market prices, and use prudent purchasing
methods-paying for the medical equipment and supplies that meet quality
standards at competitive market prices. Industry groups contend that Medicare,
the nation’s largest health care insurer, should be leading the effort to require
the use of universal product numbers, especially because this coding system
will allow HCFA to better classify products by HCPCS code, monitor suppliers’
use of the billing codes, and adjust the Medicare fee-schedule allowances to
more current market-based prices.

We met with HCFA officials to discuss the benefits of the bar coding system to
the Medicare program, though HCFA has not yet explored using universal
product numbers to track the cost and utihzation of specific medical products.
HCFA officials have not taken a position on using this coding system according
to discussions with us. At this time it is unclear whether the Secretary of HEIS
will promulgate universal product numbers as a product identification standard
using the authority provided by the Health Insurance and Portability Act of

‘lP.L. 104191, 110 Stat 1936 (1996).
7   GAOIHEHS-97-157X    Medicare   Payments for Medical   Equipment   and Supplies

Medicare reimburses large suppliers who buy at volume discounts the same fee-
schedule allowances as individuals who buy single items at retail prices. Large
suppliers who bill Medicare include home medical equipment and supply
companies and distributors who submit claims on behalf of beneficiaries in
nursing homes. Because these suppliers submit claims on behalf of many
beneficiaries, they can negotiate volume discounts for the products they buy.
Individual beneficiaries, on the other hand, lack the purchasing power to obtain
volume discounts. Therefore, fee-schedule allowances that adequately
reimburse individual beneficiaries usually overpay large suppliers, even after
accounting for their admini&ative costs.

The largest suppliers receive a significant portion of Medicare spending for
many medical products. Although more than 150,000suppliers bill Medicare for
medical equipment and supplies, claims submitted by the top 10 suppliers often
represent a large percentage of total allowed charges for certain HCPCS codes.
For example, for one particular urological HCPCS code, the top 10 suppliers
accounted for almost 55 percent of charges billed to Medicare between July 1:
1996, and September 30,1996, according to our analysis. For five other HCPCS
codes in our study, 10 suppliers accounted for 24 percent or more of total
allowed charges.

Medicare’s f-schedule allowances are excessive compared with large
suppliers’ acquisition costs for some products. For example, one supplier
reported that its weighted average cost for items billed in 1996 under the
HCPCS code for a foley catheter was less than $1. Medicare’s reimbursement
for each catheter was between $10.06 and $11.83, the 1996 respective national
floor and ceiling for this item In the same year, another supplier’s weighted
average cost for a bedside drainage bag was about $2.25, though Medicare
reimbursed the supplier between $7.65 and $9 for this item

On the other hand, for some products, such as ostomy supplies, new technology
has increased product qua&y and prices, and the Medicare payment rates do
not adequately reimburse either suppliers or individual beneficiaries for these
items. In such cases suppliers often do not accept claim assignment-making
the Medicare beneficiary responsible not only for the Z&percent copayment, but
also for the difference between the supplier’s charge and the Medicare

Suppliers who bill Medicare on behalf of the beneficiary incur admin&rative
costs associated with Gling a claim Most of these costs involve documenting

8   GAOAEHS-97-157R     Medicare   Payments   for Medical   Equipment   and Supplies
medical necessity for the initial claim. Subsequent c&us to reorder items for
the same beneficiary take less time because suppliers have already gathered
much of the information for the initial claim. According to suppliers, urological
and ostomy products are the types of items that are often reordered.

Suppliers estimate that the average administrative cost for filing a Medicare
claim for a reordered product is about $10. Because suppliers typically include
several related supplies on a single claim, this administrative cost is disbursed
among multiple items. For example, a claim for a foley catheter may also
include an insertion tray, a bedside drainage bag, and a leg drainage bag if the
patient is mobile. Disbursing the administrative cost among the three or four
items reduces this cost to between $2.50 and $3.35 per item

Market competition to reduce product costs has driven suppliers to increase
their purchasing power by consolidating with similar businesses or joining
purchasing cooperatives. Hospitals, nursing homes, and suppliers have formed
their own purchasing groups to get lower prices from manufacturers. The
medical equipment and supplies market is constantly changing as suppliers seek
to lower costs and gain new market share. Mergers, consolidations,
acquisitions, and buying cooperatives have produced suppliers with greater
purchasing power to lower product acquisition costs.

Although competitive market pressures have driven suppliers to find new ways
to reduce their product costs, Medicare’s fee schedule does not account for the
savings from these cost efficiencies. Some large suppliers have contractual
arrangements and corporate affiliations with nursing facilities and home health
agencies. These arrangements allow suppliers to take advantage of significant
volume discounts from manufacturers and wholesalers. HCFA, however, has
not considered establishing a separate fee schedule to account for discounts for
nursing facilities and home health providers that furnish medical products to
beneficiaries in their care.


We made a draft of this correspondence available for review by HCFA program
officials, and we also discussed the issues with them The agency officials with
whom we spoke expressed uncertainty about the benefits of using universal
product numbers in the Medicare program and about the need for a separate
fee schedule for medical equipment and supplies furnished to patients in
nursing homes or through home health providers. We will provide HHS and
HCFA an opportunity to comment in writing on our final report, which we
expect to provide you in September 1997.

9   GAOIKEHS-97-157E   Medicare   Payments   for Medical   Equipment   and Supplies

As agreed with your office, unless you release its contents earlier, we plan no
further distribution of this letter for 30 days. At that time we will make copies
available to other congressional committees and members of the Congress with
an interest in these matters and the Secretary of Health and Human Services.

Please call William Reis at (617) 5657488 or me at (202) 512-7114if you or your
staff have any questions about the information in this letter. Other contributors
to this study were Teruui Rosengren, Suzanne Rubins, and Thomas Taydus.

Sincerely yours,

William J. Scanlon
Director, Health FInancjng and
    systems Issues


10 GAOLHEES-97-157R      Medicare   Payments   for Medical   Equipment   and Supplies
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