By ALEX BERENSON
Published: November 6, 2006
For big drug companies, the new Medicare prescription benefit is proving to be a financial windfall larger than even the most optimistic Wall Street analysts had predicted.
But those gains may come back to haunt drug makers if Democrats take control of Congress this week.
Democrats, who have long charged that the drug industry is profiteering at taxpayers’ expense, say they want to introduce legislation to revoke the law that bars Medicare from negotiating prices directly with drug makers like Pfizer for the medicines it buys.
Medicare now pays for drugs indirectly, through the private insurers that administer the prescription program — and those insurers typically pay higher prices than government agencies, like the Veterans Administration, that buy medicines directly from drug makers.
The government is expected to spend at least $31 billion this year on the drug benefit, which provides partial drug coverage for people over age 65, according to the federal agency that runs Medicare. Next year, the program is expected to cost almost $50 billion — almost 20 percent of overall American drug spending.
Democrats say that directly negotiating with drug makers could save taxpayers tens of billions of dollars annually, though some independent analysts say those projections are probably exaggerated.
Republicans, and the pharmaceutical industry, say that the benefit program is working and has cost less than initially projected. More than 38 million Medicare beneficiaries are enrolled in the program, and most say they are satisfied with their coverage, said Michael O. Leavitt, the secretary of health and human services.
“It’s very clearly working,” Mr. Leavitt said. “We now have 90 percent of seniors in this country who have prescription drug coverage.”
But Wall Street analysts say they have little doubt that the benefit program, called Part D, has helped several big drug makers report record profits and exceed earnings forecasts made earlier in the year.
Companies have raised prices on many top-selling medicines by 6 percent or more this year, double the overall inflation rate. In some cases, drug makers have received price increases of as much as 20 percent for medicines that the government was already buying for people covered under the Medicaid program for the indigent. Medicare also pays more than the Veterans Administration, which runs its own benefit program.
“Part D was a good thing for almost everybody,” said Les Funtleyder, an industry analyst at Miller Tabak, a research firm in New York.
Drug makers have tried to play down their gains from the program because they do not want to be seen as profiteering in an election year, Mr. Funtleyder said. “You don’t want to draw too much attention to how good it’s been.”
Democrats claim the government could save as much as $190 billion over the next 10 years if it negotiated directly. Those savings could help shrink the “doughnut hole,” the gap in Part D coverage that forces many beneficiaries to pay about $3,000 a year for drugs, said Brendan Daly, a spokesman for Nancy Pelosi, the Democratic leader in the House.
“What we’re planning to do is give Medicare a chance to negotiate prices, and we’d use some of the savings to close the doughnut hole,” Mr. Daly said.
Republicans say the savings estimates offered by the Democrats are vastly inflated. They note that Medicare has already cut its 10-year projection of the program’s cost by $117 billion, though the program is still expected to cost taxpayers $516 billion over the next decade. Republicans also note that, in independent surveys, most seniors say they are happy with the benefit.
“The competitive marketplace has saved much more money than anyone has ever anticipated,” said Leslie Norwalk, the deputy commissioner of the Centers for Medicare and Medicaid Services.
Ken Johnson, senior vice president at Pharmaceutical Research and Manufacturers of America, the main lobbying group for drug makers, said that allowing Medicare to negotiate directly would be unfair because the government had too much market power.
“The government doesn’t negotiate prices — it dictates prices,” Mr. Johnson said.
Also, the Veterans Administration and Medicare plans are not directly comparable, he said, because the average Medicare drug plan covers 4,300 medicines, while the V.A. covers only 1,300.
The structure of Part D is complex. Medicare does not directly provide coverage. Instead it subsidizes plans offered by private insurers. Insurers negotiate prices with drug makers and create menus of different plans, some with high premiums and broad drug coverage and others that offer basic coverage at low premiums. All plans have to follow certain basic rules, like offering at least two medicines in every drug category.
Medicare then calculates the cost of the average plan and pays every insurer a subsidy of about 75 percent of that cost. Beneficiaries cover the rest, with the amount they pay depending on what plan they choose.
For example, if the average plan costs $100 a month, Medicare will pay all plans a $75 subsidy for everyone who enrolls, and a person who enrolls in the average plan will pay $25. In most states, beneficiaries can choose from among 40 to 60 plans, Ms. Norwalk said.
Part D has raised profits for drug makers both by increasing the prices they receive and by encouraging beneficiaries to fill prescriptions they might otherwise have been unable to afford, analysts say.
The biggest gains have gone to companies that make drugs widely used by the Medicaid program, which covers the indigent. Poor people over 65, known as “dual eligibles,” previously received drugs through Medicaid.
Drug makers were legally required to give Medicaid a discount of at least 15 percent, and sometimes significantly more, from their list prices. Now Medicaid recipients over 65 are covered through the Part D program, which does not require the same discounts. As a result, drug makers are being paid as much as 20 percent more for the same drugs that they had already been providing to recipients under the Medicaid program.
The biggest gainer, analysts say, is Eli Lilly, which makes Zyprexa. Zyprexa, used to treat schizophrenia and other severe mental illnesses, is widely prescribed to Medicaid patients.
Lilly, the sixth-largest American drug maker, reported two weeks ago that its third-quarter sales had risen 7 percent, to $3.9 billion, and its profits were up 10 percent, to $874 million, compared with 2005. According to Lilly’s published review of the quarter, the sales gains resulted almost entirely from Lilly’s prices rising 11 percent in the United States, while actually falling in Europe and Japan.
“We are experiencing a one-time sales benefit resulting from a shift of certain low-income patients from Medicaid to Medicare,” a company spokeswoman, Terra Fox, wrote in an e-mail response to questions about Part D. Ms. Fox declined to quantify how much Lilly had gained from the shift.
But Lilly is hardly alone in benefiting. Pfizer, the world’s largest drug maker, said its sales soared 14 percent in the United States in the third quarter, while rising only 3 percent internationally. Over all, Pfizer said its profits more than doubled, to $3.4 billion from $1.6 billion, though part of the difference came from high one-time charges last year.
Pfizer did not disclose how much of the sales growth came from price increases and how much from new prescriptions, but earlier this year Pfizer raised the list prices of some of its biggest drugs by 5.5 percent or more, well above the inflation rate.
Tony Butler, an analyst at Lehman Brothers, said both volume growth and price increases had driven the industry’s rising profits. But he said he did not expect major changes in the Part D plan even if the Democrats took over Congress, since President Bush would probably not sign any legislation that would allow Medicare to negotiate prices directly.
“It’s our belief that the White House will veto it,” he said.