Prescription for price controls
Medicare's new drug plan is a potential boon for everyone involved, except for Big Pharma.
By John Simons, FORTUNE

NEW YORK (FORTUNE) - By most accounts, Medicare's new "Part D" prescription drug plan is an absolute mess. Big Pharma thinks so too.

In its fourth week of operation, the government-funded insurance program to help elderly patients pay for their medications has left seniors, pharmacists and state officials dumbfounded in a maze of red tape. But once the glitches are worked out, Part D -- for which the government has budgeted $725 billion over the next decade -- will profit patients as well as pharmacies, private insurers, prescription benefits management firms (PBMs), drug distributors and generic drugmakers.

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The plan is a potential boon for everyone involved. Everyone, that is, except for Big Pharma. Medicare's new program, in fact, could to lead to what Big Pharma has feared and fought against for years: government price controls.

When Congress approved Part D in 2003, cynical Washington observers assumed the nation's second-most-profitable industry behind Big Oil had bigfooted its way into a windfall. It's certainly true that Part D will boost the sheer number of consumers who have access to Big Pharma medications. Indeed, the drug plan is expected to add a modest 2 percent to 3 percent to major drug company revenues in 2006 and 2007.

It's also true that the industry's influential lobby averted a scheme that would have allowed government to negotiate drug prices for some Medicare 42 million patients. It was no small victory. Those elderly patients consume roughly 41 percent of all drugs sold in the U.S. That portion is expected to grow to over 50 percent of consumption as baby boomers begin to retire. As it stands now, the plan calls for managed care companies to negotiate prices. As the ultimate payer, however, the government will watch closely to make certain managed care negotiates well and contains costs.

Therein lies the catch. As it looks now, "ultimately, if the private sector cannot sufficiently contain program costs, the private model will fail and the government will step in," notes IMS Health market analyst Jon Resnick. "The most likely option is for some form of price controls."

What that means is that government could set prices for more than half of Big Pharma's U.S. market in coming years. Even if there are no price controls per se, says Deutsche Bank analyst, Barbara Ryan, "as government becomes a bigger payer, pricing could go lower."

Of course, other healthcare sectors are likely to do well under the new benefit. Providers, for instance, will steer patients toward the growing number of generic drug choices across the therapeutic spectrum. Thanks to the $23 billion-worth branded medicines losing patent protection this year and the Medicare benefit, generic drugmakers are expecting a 13 percent boost in U.S. sales in 2006 to $25 billion. That will far outpace Big Pharma's projected growth of 8 percent to about $275 billion in U.S. sales.

Insurance providers and PBMs such as Caremark and Medco will gain from the sheer number of patients signing on. And distributors like McKesson and Amerisource will move more volume. Initially, some major drug companies may see modest gains, especially makers of so-called "maintenance" drugs used largely by seniors to fight ailments like cholesterol, heart disease and arthritis. As a result, Pfizer and Merck could see "a tickle in unit growth" of some of their drugs in those categories this year and next, says Deutsche Bank's Ryan.

Carl Seiden, an analyst with UBS Investment Research notes that Eli Lilly will see a small boost in sales of its market-leading anti-psychotic, Zyprexa, this year. Why? The ranks of the formerly uninsured include very destitute patients who weren't getting the meds they needed in the past. "Zyprexa will enjoy a $150 million gain just from that change," says Seiden.

Overall, though, Big Pharma won't be happy with Medicare Part D's outcome, a situation that could worsen for them if Democrats do well in next November's midterm Congressional elections. Top of page

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