How about a surgery to go with that implant? -(Part 1)

Unraveling mysteries of the implantable medical device industry

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For the next couple of weeks, we are taking a look at a pocket of the industry that doesn’t get talked about in “health-tech” even though it was the original health-tech. Part 1 of this series first covers the market dynamics, regulatory requirements and reimbursement in the medical device industry and later takes a focussed look at implantable medical devices. Part 2 of the series covers the market inefficiencies and policy options to create transparency in this opaque pocket of healthcare.

I spent 7 years working in the medical device industry. During my time, I helped develop surgical devices used in womens health and interventional devices used in coronary procedures. Most people (myself included at the time) who work in the industry have a limited understanding of the underlying financial mechanics of selling a medical device. This post dives deep into the payment models, market inefficiencies and policy options to create a well functioning, competitive market.

I have worked inside and outside the industry and understand the differing points of view. I get the argument for R&D investments and the need for appropriate incentives for risk taking. Medical devices are magical in what they can do and the scientists and engineers who come up with innovations deserve admiration and respect for their contributions to healthcare. These devices have helped alleviate pain, restore health and extend life for millions of people. Still, it is worth reflecting on the systemic issues and valid counter-arguments about regulatory oversight, overuse and lack of transparency in performance and prices, instead of brushing them under the rug. Let’s dive in.

Medical Devices

The term, medical device applies to a wide range of products - common supplies such as gloves and syringes to advanced imaging equipment and implantable devices such as artificial hips, heart valves and deep brain stimulators. The Federal Drug Administration (FDA) regulates medical devices and defines it as -

An instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article for use in the diagnosis of disease or other conditions, or in the cure, mitigation, treatment, or prevention of disease to affect the structure or any function of the body and which does not achieve its primary intended purposes through chemical action.

The US spends almost $200 billion on medical devices accounting for about 5% of the $4 trillion of total national healthcare spend and accounts for about 40% of the global medical device market. The industry could be divided into many sub-segments - commodity medical supplies or consumables, surgical tools, capital equipment, consumer medical devices, durable medical equipment etc. The market dynamics vary significantly in each segment - in terms of manufacturing costs, sales prices, gross margins, technology, barriers to entry, regulatory climate and competition.

There are some parallels with the pharma industry. The most complex medical devices go through years of R&D and regulatory hurdles to make it to the market. For certain sub-segments such as implantable medical devices, the prices are high and market dynamics opaque just like the pharma industry. However, there are also notable differences. The regulatory requirements to demonstrate safety and effectiveness are somewhat lax compared to drug approvals and have resulted in significant negative attention to industry practices in the last few years (Implant Files Investigative Journalism, Bleeding Edge Netflix Documentary) Another important difference is that physicians are heavily involved in the development of medical devices. Manufacturers seek input about the design, use cases and feedback from physicians who use their products. Physicians are direct and hands-on users. They often have creative insights on improving procedures and invent new medical devices that are then commercialized by device makers. As a result, there is a much closer bond between device makers and physicians (more on this topic later)

This post focuses on one sub-segment - Implantable Medical Devices.

Getting Implantable Medical Devices (IMD) to market

One in ten Americans will have a medical device implanted over their life. These devices include artificial knees, hips, heart valves, pace makers, coronary stents, cataract lenses, deep brain stimulators etc. IMDs use advanced technology, materials and innovative methods to treat complex conditions of the human body. However, the approval standards to bring these devices to market are less stringent than the pharma industry. Less than 1% of devices have been tested in rigorous clinical trials.

The higher risk devices must go through an FDA process called pre-market approval (PMA) that requires human clinical trials. It costs almost $100 million and takes 180-270 days for a device to get a PMA on average. Less than 100 PMAs are filed with the FDA each year. In fact, even the PMA process is not as demanding as the approval process for a new drug. Further, when a device is approved, the manufacturer can make minor modifications without submitting new clinical data by filing a supplement to the PMA. A study found that cardiovascular implants have as many as 50 supplements for each original PMA.

As long as a device can claim itself to be substantially equivalent to a device already cleared by the FDA, the device does not need to demonstrate safety or effectiveness in a clinical trial. This route is called the 501(k) process. To bring a medical device to market, it costs $31 million and takes 90-120 days through a 510(k) on average. About 700 510(k) applications are filed with the FDA each year. The 510(k) process design means that there is a daisy chain of regulatory clearances, each claiming substantial equivalency to a predicate, to the point where the original approval may be quite different than the last one in the chain. Within this chain there are other subchains that are approved via a process called “letter to file” notifying the FDA about a particular change. The vast majority of implantable devices are considered as intermediate risk (Class II) and can be cleared for the market through an administrative process called 510(k).

Market Dynamics of IMDs

Many hospitals work with Group Purchasing Organizations (GPOs) to buy medical supplies. However, for implantable medical devices and other high cost surgical tools, called physician preference items, medical device companies do not contract with GPOs and market to individual physicians instead, who can act as champions with hospital administrators. As a result, the market for advanced products is harder to enter without an established sales force, resulting in less competition and opaque prices. Broadly speaking, the top 20 medical device companies account for 67% of the overall medical device market. These dynamics have created an oligopolistic market for many high volume procedures, where device companies charge high prices and can maintain high profit margins. To put these numbers in context, four companies account for 95 percent of knee and hip implant sales and three companies account for 90 percent of cardiac pacemaker sales. An $8,000 hip implant costs $350 to manufacture. Earnings before interest, taxes, depreciation and amortization (EBITDA) margins are very healthy at 20-30%. Just like the rest of the healthcare industry, prices vary dramatically and are shrouded in secrecy with gag clauses on disclosure.

Besides the market concentration, the reason to look at Implantable Medical Devices is because the purchase price for an IMD can make up for 30-80 percent of the insurers payment to a hospital for a procedure! - begging the question, are you buying an implant or a surgical procedure?

How are medical devices paid for?

Like all healthcare reimbursement, Medicare is the trend setter. So let’s look at Medicare first. Medicare pays indirectly for most medical devices (other than Durable Medical Equipment) as components of the cost of delivering care to patients. Providers (ie Hospitals and other facilities) are reimbursed for devices used in care delivery as a part of the total bundled price not per device. For inpatient (hospital visits requiring overnight stays) and outpatient (visits resulting in same day discharge) Center for Medicare and Medicaid Services (CMS) takes into account the cost for the medical devices using cost reports submitted annual by Hospitals. The cost reports are used to calculate cost to charge ratios of major categories or cost centers for the hospital. This analysis is used to set inpatient prospective payment system (IPPS) and outpatient prospective payment system (OPPS) rates for hospitals. For individual physicians CMS uses survey data from specialty societies that collect time and intensity in providing services, practice costs and medical devices used and sets the Physician Fee Schedule (PFS). Given the nature of data collection, the process involves significant inaccuracies. For Durable Medical Equipment (DME) Medicare used to have a Fee Schedule, but has moved to a competitive bidding process where rates are set as the median price of the winning bids.

Using high priced, latest technology devices cuts into hospital margins creating an incentive for hospitals to use lower cost devices to reduce its cost burden in the bundled payment. Hospitals favor price transparency in medical devices to empower them to shop around (ironic, I know). However, individual physicians (surgeons, cardiologists etc) are generally not financially responsible for the cost of the device. As a result, physicians do not have an incentive to use lower priced devices. In fact, using the latest technology, regardless of clinical superiority is a point of pride.

Medical devices such as implants are only sold to healthcare providers such as hospitals and provider. As such, making new devices eligible for reimbursement is a primary consideration for manufacturers. Ensuring coverage from Medicare is particularly important since private health insurers typically follow along. For new devices that do not fit into an existing service code, medical device companies can apply for coverage by requesting a “national coverage determination” (NCD) or a “local coverage determination” (LCD) for the procedure that involves the device. Medicare and other private health insurers may choose to review evidence for devices and decide which ones they will cover, even for devices that are cleared or approved by the FDA.

Adapted from: https://www.meddeviceonline.com/doc/from-approved-to-covered-what-medical-device-companies-need-to-know-0001

How Are Implantable Devices Paid For?

The implications of bundled payments are even larger for implantable medical devices. The cost of an implantable medical devices is a significant chunk of the overall costs of an inpatient stay or outpatient procedure. Hospital administrators are hawks about medical device spending because they need to keep their costs below the total Medicare payment rate.

In many cases, health plans and insurers, such as Medicare, do not pay directly for a specific device. Instead, they agree to pay a fixed rate set in advance for hospital services related to the surgical procedure, including the implantable device, supplies, drugs, nursing care, and—in the case of inpatient procedures—hospital room and board. For instance, for a hip replacement, Medicare will pay for all costs related to the surgery needed to implant an artificial hip, including the device—Medicare does not pay the hospital separately for the specific implanted device. Devices implanted in both inpatient and outpatient settings are reimbursed under this “bundled payment” model. However, some private insurers pay the hospital a per diem amount plus a supplement for the device. Typically, surgeons are paid separately for the procedure to implant the device.

On the flip side, private insurers, lack the leverage of Medicare and are forced to “carveout” payments for IMDs. Private insurers pay for IMDs separately instead of bundling them as a part of the procedure. In fact, some hospitals can even add a significant markup when they negotiate payment rates for IMD carveouts. These carveouts can become a source of profit for the hospital since they are marked up as a percentage of purchase price, leading to a perverse incentive to use more expensive devices for patients on private insurance. To control costs, some private insurers contract with Device Benefit Managers (intermediaries between manufacturers and hospitals - similar to pharmacy benefit managers - covered in here) such as IPG Surgical and Access Mediquip.

Let’s take a break. Do you have a different point of view? Reach out or comment below and share where I got things right and where I got them wrong. Always open to feedback!

Thanks for reading hick-picks! If you enjoyed reading, please like, comment, share and subscribe. You can find me on LinkedIn, Twitter, tejasinamdar.com