Hospitals to shift CMS hip, knee implant cost pressure to medical device makers: Report

3-D printed Triathlon Tritanium Knee System--Courtesy of Stryker

Medical device makers, not hospitals, will get squeezed in the coming years as the Centers for Medicare and Medicaid (CMS) implements its value-based pricing scheme for hip and knee implant procedures. This is the first mandatory bundled payment initiative from the U.S. agency, although it previously has piloted bundled payment programs and value-based reimbursement such as penalties for hospitals with above-average patient readmissions.

Known as the Comprehensive Care for Joint Replacement (CJR), the program went into effect on April 1. But financial penalties don't start to phase in until the second year. Payment will be made as a procedural bundle, not separately for the implant and hospital care, and by the fourth year of the program up to 20% of payment will be eligible for claw back in underperforming hospitals.

The program applies to 789 metropolitan hospitals and excludes rural ones; together these account for about one-third of hip and knee replacements covered by Medicare. Medicare paid for more than 430,000 lower-extremity joint replacement in 2014, which is roughly half of these procedures in the U.S. The agency expects to save about $343 million, or about 3% of its expenditures, over the 5-year CJR plan from April 2016 through December 2020.

But all that cost savings won't come from hospitals themselves, according to a new report from S&P Global Ratings by analyst David Kaplan. The group is among the three major credit ratings agencies--and it sees medical device makers as the ones set to absorb these costs.

"As hospitals' orthopedic departments face margin pressures, we expect them to attempt to pass through some of that to medical device companies (with regard to devices used on both Medicare and non-Medicare patients)," said the report. "This may hold true especially for hospitals that fail to meet cost-reduction targets under the CJR program and have income clawed back by Medicare. We also expect hospitals facing margin pressure to increase their willingness to shift volume from their existing suppliers in return for lower device costs, increasing price-based competition among device makers."

Who's most at risk among the medical device players for hospital pricing pushback in the coming years? S&P covers 5 major medical device companies that are involved in hip and knee implants: DJO Global, Johnson & Johnson ($JNJ), Stryker ($SYK), Zimmer Biomet ($ZBH) and private contract manufacturer Tecomet.

S&P expects that Zimmer Biomet and Tecomet have the most exposure to hospital revenue pushback stemming from the CJR implementation, since hip and knee devices contribute more than 60% of revenues for each. Zimmer Biomet could help offset some of these pressures as it continues to wring cost synergies from its Biomet merger.

Stryker has less exposure, with 27% of revenues coming from hip and knee products, while J&J and DJO each have less than 10% of revenues derived from there.

Other payers are expected to follow Medicare's lead in tying reimbursement to patient outcomes, with the trend eventually moving beyond orthopedics. This will push medical device companies to refocus R&D efforts toward technology that lowers total episode costs--versus their traditional bias to incremental product enhancement.

In addition to pricing pressure, devicemakers are also likely to face less risk-tolerance from hospitals that could translate into fewer procedures--as they focus only on the patients who are most likely to benefit from them.

"We expect the CJR initiative to discourage joint replacement procedures for patients with an elevated risk of complications or those with comorbidities who are likely to require an extended rehabilitation. This is likely as hospitals gather sufficient statistical data to identify which risk factors contribute most predictably to complications because that data will discourage both patients and doctors from proceeding with procedures," summed up the S&P report.

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