With market-based fees and increased Medicaid rebates set to start several years before drug manufacturers will see any benefit of an expanded market from health care reform, consultants are suggesting several ways to counter the short-term negative effect on earnings, including continued cost-cutting and diversification.

The health care reform bill, signed into law March 23, with fixes signed March 30, promises to expand access to insurance, and with it prescription drugs, in 2014, providing the potential to increase future earnings. But it was also designed to make sure revenues started coming in to the government well in advance of the expanded coverage.

As Bill Sarraille, a partner with the law firm Sidley Austin, noted in an interview, "That's consistent with the overall policy, which is to front-load the pain and to back-load the benefits to secure a more favorable [Congressional Budget Office] estimate." CBO scored the combined health care reform bills as reducing federal budget deficits by $143 billion over the 10 years from 2010 to 2019.

Costs Could Add Up To $105 Bil. Over 10 Years

So some costs to the biopharma industry, such as a large increase in the base Medicaid brand drug rebate, from 15.1 percent to 23.1 percent, applying the rebate to new formulations of solid oral drugs, and applying the rebate to Medicaid managed care organizations, take effect in 2010. Not only will manufacturers pay more to Medicaid programs, but the higher rebate is expected to cause private payers to seek higher discounts on drugs too (¹ Also see "Higher Medicaid Rebates Expected To Boost Private Payer Discounts Too" - Pink Sheet, 5 April, 2010.).

CBO estimated those items would save the federal government - and cost the industry - $38 billion over 10 years. The first four years of those payments will come before insurance coverage expansions.

Other costs, such as a 50 percent discount on drugs used by Medicare Part D beneficiaries in the coverage gap and an annual market-share based fee on drug manufacturers, will take effect in 2011. The discount will cost industry $32 billion over 10 years, according to an estimate by Avalere Health, and the schedule of fees outlined in the law comes to $28 billion over 10 years. The first three years of those costs will come before coverage expansion.

During a health care reform Webinar sponsored by Avalere Health on March 26, Avalere consultant Margaret Nowak looked at the overall costs to the pharmaceutical industry from the new law and noted that "the financial impact for pharmaceutical manufacturers is larger than originally envisioned a year ago," when the industry tried to limit its contribution to $80 billion over 10 years.

She estimated that the "financial responsibility has increased to approximately $105 billion over the next 10 years." In addition to $38 billion from Medicaid rebates, $28 billion from the industry fee, and $32 billion from the 50 percent discount in the coverage gap, follow-on biologics will cost the industry about $7 billion under Avalere's projections.

In addition, the loss of the tax deductibility of subsidies the government provides to employers to continue providing drug benefits to retirees, rather than dump them into Medicare Part D, will cause many large employers, including drug manufacturers, to take an immediate charge against earnings (² Also see "Medicare RDS Tax May Prompt Employer Coverage Shifts, Focus On Rx Costs" - Pink Sheet, 5 April, 2010.).

[Editor's note: For a list of all of the Medicaid and other provisions affecting the pharmaceutical industry, see our ³ 'Timeline Of Pharma Provisions' chart in "The Pink Sheet," March 29, 2010.]

Countering The Dilutive Effects Of HCR

David Womelsdorf, a partner in Ernst & Young's life sciences practice, said in an interview, "In general, I would tell you that my clients are concerned about the dilutive impact of health care reform in 2010 and 2011, in advance of the increased covered population, which will drive a lot of benefit for them." Womelsdorf's clients are large pharmaceutical manufacturers.

"There's a lot of short-term concern. And the concern is being driven a lot by the fees," both because of the size of the fees and the fact that those fees are not tax deductible, he said. (See sidebar: ⁴ Annual Fee On Brand Drug Manufacturers Explained ).

"You couple that with the expectation of increased pricing pressure in the marketplace from not only the government but from managed care, you couple that with the increased rebates in terms of Medicaid rebates going up as much as 53 percent - very significant in driving a lot of concern - and then ... the loss of the tax subsidy for retirement drug benefits."

Consultants believe the main avenue manufacturers will have to try to counter those negative pressures on earnings will be to continue cutting costs.

Bonnie Washington, a consultant with Avalere Health, said manufacturers are examining some of the commercial decisions they'll need to make, including "looking at price and looking at creating efficiency and cutting cost and that sort of thing."

Those decisions are likely to build on some industry trends that have developed in the last couple of years.

"As we've seen over the last several years, there's the mergers of the big companies as well as lots of reports of companies downsizing their sales forces and reorganizing," Washington said. "I think there's been a big focus in the last couple of years on creating efficiency and saving money that way as lots of these companies, even before health reform, were looking at the patent expiration of some of their major products. ... [Health care reform] just kind of adds to the urgency to do that." Companies are already facing a rash of patent expirations on branded drugs in the next couple of years (⁵ Also see "The Year Ahead For Generic Drugs: The Calm Before The Storm" - Pink Sheet, 25 January, 2010.).

Womelsdorf agreed that cost-cutting will be part of the equation, but added some other strategies as well.

"I think there are a number of things that companies are doing or should be doing or should accelerate, given reform being approved, things like the acceleration of various cost-reduction programs and restructurings," he said. "So, I think a big one is you've got to reduce your cost structure."

He also said, "You could see some companies raise prices to offset the increase in the Medicaid rebates where they can with managed care and other customers."

In addition, "you may see a further diversification within the industry" into businesses like animal health and consumer products (see "⁶ Also see "Pharma's Strategic Divide: Focus or Diversify" - In Vivo, 1 September, 2008.," IN VIVO, September 2008).

And finally, he said there needs to be "a focus on really transforming their whole ... commercial model, how they market and sell their products in this new environment," with managed care and the government sector becoming even more important than in the past.

What Benefit From Market Expansion?

The expanded market will not get going until 2014, when 32 million individuals who would not have been covered otherwise will have health insurance. Nearly half of those are expected to be enrolled in Medicaid with its expanded eligibility criteria, and the remainder will enroll in private plans through state exchanges.

It is difficult, however, to quantify the benefit to drug manufacturers from the eventual market expansion.

Nowak noted that of the newly insured individuals in 2014, many of those will be going into Medicaid "where there is considerable pricing pressure for manufacturers." For those choosing plans through state exchanges, "it is unclear at this time what the true impact of the exchanges will be for manufacturers. The impact will be largely dependent on the overall economy as well as federal budgetary pressures."

During the writing of the health care reform legislation, the Pharmaceutical Research and Manufacturers of America downplayed the effect of increased sales volume from the expanded insurance market, saying the increase would not be substantial because many of those who are now uninsured and would gain access through the exchanges are young healthy people who are not likely to need a lot of medicines.

Womelsdorf said the age and health status of those currently without insurance is "an area that has not been fully explored and is not fully understood. But it is being examined, and as companies think through their business model and how they're going to reach new customers, new patients, these new payers, that all has to be factored in."

Adding to the uncertainty is the fact that many of the provisions in the law will be implemented through agency guidance and rules, with the final language of those yet to be known.

Another unknown is the creation of the Independent Payment Advisory Board, which under the new law will have broad authority to make binding recommendations for ways to cut costs in Medicare products and services. The industry tried to fight its inclusion in the bill, but ultimately it survived.

In addition, if predicted government savings through the law fail to materialize, Congress may need to revisit the legislation and seek more of a sacrifice from different health care industries.

"That's the danger of signing onto a bill like this," Sarraille said, "is that you really don't know where it's going to take you from a federal budget perspective and therefore ultimately in terms of what the lay of the land might be after Congress has revisited the issue and the implementing agencies have used the full set of options available to them to ratchet down costs."

Some Short-Term Benefits

Still, there could be some small boosts to pharma in the short-term. For example, the 50 percent discount for drugs taken in the Part D donut hole could encourage patients to stick to their drug regimens rather than drop them because of the cost. But again, it will be years before the donut hole is completely phased out; beneficiaries' maximum coinsurance for drugs in the donut hole will drop to 25 percent in 2020.

Also, there is the new insurance reform that eliminates lifetime limits on spending, which could benefit high-cost drugs that currently push patients over limits, often resulting in manufacturers covering much of the costs for those patients. The elimination of the cap is set to take effect Sept. 23, 2010.

Sarraille explained that the caps "for some pharmaceutical products, for instance, clotting factors, can be a very serious limitation on access to care and can essentially force manufacturers to carry the very significant cost of some patients in the form of patient assistance programs."

And longer term, there is the fact that the annual fees on manufacturers, after climbing until 2018, will drop in 2019 to $2.8 billion annually and stay there, without being indexed for inflation.

In the end, Womelsdorf said, "you could assume that the increased population is going to drive up total product usage and revenue. So net-net, I think as reform rolls out, the pharmaceutical sector will benefit more and more."

- Scott Steinke ( ⁷ s.steinke@elsevier.com )

Strategies To Ease Short-Term Earnings Pain From Health Reform Include Cost-Cutting, Diversification

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