Prospective Payment System Final Rule Benefits Device, Pharmaceutical, and Biological Industries

On April 7, 2000, the Health Care Financing Administration (HCFA) published its final regulation (65 FR 18,434 et seq.) for the hospital outpatient prospective payment system (PPS) for Medicare beneficiaries. The PPS was mandated by the Balanced Budget Act of 1997 (BBA) and modified by the Balanced Budget Refinement Act of 1999 (BBRA). The effective date for the PPS rule is July 1, 2000.

PPS Overview

HCFA's primary objective for the PPS is to simplify the complicated Medicare payment system and encourage hospital efficiency in providing outpatient services, while at the same time, according to HCFA, ensuring that payments are sufficient to compensate hospitals adequately for their legitimate costs. Certain services designated by HCFA as "inpatient only" are excluded from Medicare payment under the PPS payment system. To implement the PPS, HCFA established ambulatory payment classification (APC) groups for the covered outpatient services. The APC groups are organized so that the services within each group are clinically similar and require similar resources. The PPS uses 451 APC groups. The PPS is particularly important to the medical device, pharmaceutical, and biological industries because the final rule provides for transitional pass-through payments to hospitals for a period of two to three years for additional costs associated with new medical devices, drugs, and biologicals. The PPS final rule also creates special APC groups for new technology services that HCFA determines cannot be placed in existing APC groups and that do not meet the pass-through requirements.

Transitional Pass-Through for Additional Costs of Innovative Medical Devices, Drugs, and Biologicals

Section 201(b) of the BBRA required HCFA to provide hospitals with an additional payment, under certain circumstances, for current orphan drugs; current cancer therapy drugs, biologicals and brachytherapy; current radiopharmaceutical drugs and biological products; and new medical devices, drugs, and biologicals. "Current" refers to those items for which hospital outpatient payment is being made on the first date the PPS is implemented (July 1, 2000). "New" refers to items not in, or not represented adequately in, HCFA's 1996 database.
The BBRA set the additional payment amount for drugs and biologicals as the amount by which 95% of the average wholesale price exceeds the portion of the otherwise applicable hospital outpatient department fee schedule amount that HCFA determines to be associated with the specific drug or biological. The additional payment for medical devices is the amount by which the hospital's charges for the device, adjusted to cost, exceeds the portion of the otherwise applicable hospital outpatient department fee schedule determined by HCFA to be associated with the device.
The BBRA established two additional criterion for the transitional pass-through payment for new medical devices, drugs, and biologicals: 1) payment for the device, drug, or biological as an outpatient hospital service was not being made as of December 31, 1996; and 2) the cost of the device, drug, or biological is not insignificant in relation to the PPS amount.
In the PPS final rule, HCFA generally excluded equipment, instruments, apparatuses, implements, or items that are used for diagnostic or therapeutic purposes, that are not implanted or incorporated into a body part, and that are used on more than one patient (i.e., are reusable from being considered new medical devices) 65 FR 18479. HCFA noted these materials are generally considered to be hospital overhead costs and the depreciation expenses associated with them are reflected in the APC payments.
Notwithstanding the HCFA exclusions, implantable items, including pacemakers, defibrillators, cardiac sensors, venous grafts, drug pumps, stents, neurostimulators, and orthopedic implants, as well as items that come in contact with human tissue during invasive procedures, are eligible for pass-through payments. Items that contact human tissue include reusable cardiac catheterization devices. HCFA will not pay for implantable items under the transitional pass-through payment if the item is reimbursed by the durable medical equipment, prosthetics, orthotics, and supplies (also referred to as DMEPOS) fee schedule when the hospital is acting as a supplier. In the PPS final rule, HCFA established a three-part test (65 FR 18,480-481) to determine if the cost of the device, drug, or biological is not insignificant in relation to the PPS amount:

1) its expected reasonable cost exceeds 25% of the applicable fee schedule amount for the associated service; 2) the expected reasonable cost must exceed the portion of the fee schedule amount determined to be associated with the drug, biological or device by 25%; and 3) the difference between the expected, reasonable cost of the item and the portion of the hospital outpatient department fee schedule amount determined to be associated with the item exceeds 10% of the applicable hospital outpatient fee schedule amount.
HCFA's objective in establishing the "not insignificant" threshold test was to prevent the PPS payment system from creating disincentives for the diffusion of valuable new technology by initially paying a rate significantly below the costs of the items (65 FR 18,480) with a formula that would not create an excessive number of pass-through items. Importantly, an item that qualifies for pass-through payment shall retain this status for at least two years, but no more than three years.
HCFA identified in the PPS final rule a significant number of items that they believe qualify for transitional pass-through payments. However, HCFA readily concedes that they may be unaware of additional items that may qualify for pass-through payments, and they have requested that manufacturers and other interested parties bring these items to their attention by providing specific information along with their written request.
HCFA will update the outpatient PPS with additional items qualifying for pass-through payments on a quarterly basis beginning October 1, 2000.

Payment for New Technology Services

HCFA excluded certain items from being considered "new" medical devices eligible for pass-through payments. However, the PPS final rule created new technology APCs to accommodate new technology services that may be performed using equipment or instrumentation that is capitalized, depreciated, and used on more than one patient.

To be considered for assignment to a new technology group, an item or service must meet the following criteria:

1) it could not have been billed to the Medicare program in 1996, or if it was, the costs of the item or service could not have been adequately represented in the 1996 data; 2) it does not qualify for the transitional pass-through payments; 3) it is identified under the HCFA Common Procedure Coding System (HCPCS); 4) it is within the scope of Medicare benefits and has been determined to be reasonable and necessary; and 5) it passes the "not insignificant" test discussed above.

In contrast to other APC groups, the new technology APC groups are not based on the clinical aspects of the services they are to contain, but only on their costs. HCFA will assign new items and services that they determine cannot be placed appropriately in existing APC groups for established procedures and services to the new technology APC groups. The payment rates for the new technology APC groups are based on the midpoint of a range of possible costs. The final APC groups for new technology are APCs 0970 through 0984, and cover a range of costs from less than $50 to $6,000. HCFA has reserved the right to modify these cost ranges as they gain experience under the PPS.
The placement of a service in a new technology APC will be for a minimum of two years, but a maximum of three years. After HCFA gains sufficient information regarding actual hospital costs incurred to furnish a new technology service, HCFA will move the new technology to a clinically related APC group with comparable resource costs. If the new technology service cannot be moved to an existing APC because it is dissimilar clinically and with respect to resource costs from all other APCs, HCFA will create a separate APC for the service. The shift from a new technology APC to a clinically related APC will occur as part of the annual update of APC groups. HCFA has requested that interested parties bring information regarding those items which may qualify for a new technology APC to HCFA's attention.

PPS Benefits to the Device, Pharmaceutical, and Biological Industries

The PPS final rule will affect virtually every hospital in the United States. The two notable exceptions are all hospitals in Maryland that operate under the Maryland payment system, to the extent that the Medicare waiver applies, and critical access hospitals paid under a reasonable cost-based system. After the implementation of PPS, Medicare will have completed the transition from cost-based reimbursement systems to prospective payment for nearly every type of healthcare provider. As more treatments are conducted in the hospital outpatient setting, the BBRA and PPS provide device manufacturers and the pharmaceutical and biological industries with increased opportunities to receive additional reimbursements for their products. The transitional pass-through payments, even though the "not insignificant" test threshold may prove a difficult hurdle for some, should mitigate disincentives for hospitals to purchase new technologies. The creation of separate APCs for new technologies will ensure that new technologies are compensated, although the level of payment still may be an issue. HCFA has requested that these industries inform it of any products which may qualify for transitional pass-throughs or payments for new technologies, and those companies with products that may qualify would be well-served by taking advantage of the opportunity to receive additional revenues for their technological advances.

Dr. Reiss is a Partner and Chairman of Saul Ewing's Health Law Department. He can be reached at jreiss@saul.com. Mr. Armon is an Associate in Saul Ewing's Health Law Department and can be reached at barmon@saul.com.

Reprinted with the permission of FDLI.
Bruce D. Armon and John B. Reiss, PPS Final Rule Benefits Device, Pharmaceutical, and Biological Industries, FDLI UPDATE, Issue 3, 2000 at 46. Visit FDLI's Update magazine at www.fdli.org to download the entire issue or to access more articles by leaders in the food and drug law field.