This Is Going to Hurt

The President and the Congress are sounding the alarm that spending on healthcare is out of control, and warning that it threatens our long term economic stability. Their focuses are primarily on finding savings within Medicare and Medicaid (which are growing exponentially), and reaching the goal of universal coverage among American citizens. While the final details of the healthcare reform bill have yet to be determined, there are several near-certainties for which pharmaceutical and biotechnology companies should be prepared as they develop forecasts and for the next five or six years. These include:

• Minimum mandated Medicaid rebates will increase from average manufacturer price minus 15.1 percent to somewhere around AMP minus 23.1 percen
  

• The new minimum mandated rebate will apply to Medicaid plans, including (for the first time) those managed by commercial health plans (Managed Medicaid Plans), where the commercial rebate levels were

• previously applied.
  

• The new minimum mandated rebate will apply to the estimated 9.6 million dual-eligible Medicare beneficiaries
  

• Medicare Advantage Prescription Drug Plans and stand-alone Prescription Drug Plans will demand deeper discounts, in line with the rebates paid for the dual-eligible/LIS (low-income subsidy) beneficiaries for their non-dual/LIS beneficiaries.
  

• Commercial health plans will intensify their commercial rebate requirements for access and placement nearer to the mandated minimum rebates in response to narrower profit margins.

Medicare and Medicaid Funding and Eligibility
The Medicare program was created in 1965 by the Medicare Act, and was implemented the following year. But it did not contain a prescription drug benefit. With the passage of the Medicare Prescription Drug, Improvement and Modernization Act (MMA), which went into effect on January 1, 2006, seniors and people with disabilities now have a Medicare drug benefit.

MMA requires PDPs and MA-PDs (most of which also have commercial business) to assume Medicare pharmacy risks (MA-PDs assume medical and pharmacy risk). It also provides federally funded coverage for iow-income subsidy (LIS) eligible beneficiaries. For the first time in history, MMA made the federal government the largest single healthcare payer in the US, currently covering 34 percent of total healthcare expenditures nationwide. And in the next six years, an additional 20 million people will age into Medicare eligibility.

Also established in 1965, Medicaid is an entitlement program that provides a safety net of medical assistance for low-income individuals and families. Through Medicaid, low-income elderly citizens were previously able to obtain a prescription drug benefit. With the advent of the MMA, they now receive their drug benefit through Medicare.

In 2008, the program served an estimated 50 million people, including about 8 million who were dually eligible for Medicare and Medicaid. However, Medicaid is financed through general revenues, therefore solvency is not an issue per se, as there is no “fund” to run out. On the other hand, government analysts are raising concerns about its sustainability.

In its first annual fiscal report on Medicaid, released in October 2008, the CMS Office of the Actuary concluded, “Medicaid cost projections point to the continuing need for policymakers to consider the implications of further rapid cost growth relative to the economy and to take action as necessary to address those implications. Such action will likely be required at both the Federal and State levels.” Analysts also stressed the need to “consider Medicaid in the context of all other healthcare programs, since many of the challenges facing Medicaid are the same as those facing Medicare and sponsors of private health insurance.” It is one of the largest budget items for states, typically accounting for 20 to 21 percent of total state spending.

Medicaid has grown faster than the US economy at large. It now represents 7 percent of the federal budget, and is projected to account for 8.4 percent by 2013. Total Medicaid expenditures on benefits were $329.4 billion in 2007, and according to the Office of the Actuary they are expected to grow an average of 8 to 9 percent per year for the next 10 years, reaching $735.2 billion by 2017.

Anticipated Market Changes
In light of the size and growth trajectories of public sector programs, there are four market shifts that will substantially impact pharmaceutical rebates across segments, and should be considered when making future income and revenue projections

Mandated Minimum Rebate in Medicaid Increases to Cover Program Expansion. Currently, about 41 million people have pharmaceutical coverage through Medicaid, and more are being added to the Medicaid rolls daily. Meanwhile, state budgets are deteriorating and the recession will continue to affect them. Medicaid expenditures are estimated to increase 9.6 percent in 2009, and could increase more if unemployment continues to rise. Add to all this the determination of the new Obama administration to enact healthcare reform, and changes to Medicaid are certain.
Pharmaceutical companies should expect to feel an additional squeeze in Medicaid in 2010, as it is a nearly a foregone conclusion that Congress will increase the mandated minimum rebate in Medicaid regardless of its success or failure implementing broader healthcare reform. Pharmaceutical companies should expect the mandated minimum rebate to increase from 15.1 percent to approximately 23.1 percent.

Deep Medicaid Rebates Applied to New Books of Business. Medicaid is one of the least profitable customer segments for pharmaceutical manufacturers, and may soon become even less profitable. On the other hand, Medicare has been one of the most profitable customer segments (since 2006 when the Medicare Modernization Act went into effect), but may not be for long as Medicaid-level rebates expand to drugs for the dual-eligibles in Medicare.Once the mandated minimum rebate has been adjusted, and those rebates are applied to people on managed Medicaid, it’ll start to hurt. Apply these rebates to the dual-eligible population in Medicare, and there will be a painful confluence of events that really hit the bottom line for pharma. Medicare plans-which are already feeling the squeeze from Congress through shrinking reimbursement rates for MA-PDs, cuts to independent medical education and new networking requirements-may seek offsets through greater rebate requirements for their non-dual Medicare plans.

Public Sector Expansion Leads to Rebate Pressures. In spite of the enormous burden that Medicare and Medicaid place on the US economy, Congress is intent on broadening access to these programs. This expansion will also lead to rebate pressures.

The Medicare Improvements for Patients and Providers Act of 2008 broadened LIS eligibility. Bringing more people into a subsidized benefit will definitively increase costs to the federal government. In addition, the current healthcare reform proposals seek to increase Medicaid eligibility from 115 percent of the Federal Poverty Level (FPL) to 150 percent of the FPL. (This would also have the net effect of increasing the number of Medicaid and dual-eligible lives subject to the deepest rebates).

The Tri-Committee bill and the two Senate healthcare reform proposals also include a provision to allow 55-64 year old citizens to buy-in to Medicare. These individuals, who currently either pay cash for their drugs or are working (and may retire if they can secure healthcare coverage through Medicare), would receive public sector benefits subject to the deeper rebates.

Commercial Market Response to Government Health Plan Pressures. Finally, if a government-run plan is introduced that competes with private plans, commercial plans will seek to reduce their operating costs wherever possible while remaining an attractive alternative for businesses and individuals. From its inception, a government run plan would not have the same pressures to return investment for shareholders.
It remains to be seen how attractive a government plan alternative would be to businesses that currently offer health/pharmacy coverage, but would surely draw a portion of policyholders. If the government plan requires Medicaid or even VA level rebates, pharmaceutical companies will see a revenue reduction for the same life once it moves into the new benefit. Under pressure to compete against a plan that does not have profitability requirements, private insurers will seek to cut costs where possible and gain additional revenues where possible, likely in part through deeper drug rebates

Growth in Medicare and Medicaid place these programs on an unsustainable trajectory. Add to that Congress’ desire to expand program access a broader constituency, and the need to find funds to offset costs becomes critical. Congress is sure to look to pharmaceutical companies for those funds.

We are on the precipice of a dramatic shift in lives between each book of business due to population demographic and economic changes. As pharmaceutical companies look develop their forecasts, a careful analysis of the revenue and profit contribution of each book of business (Medicare, Medicaid, and Commercial) will essential. For accurate business and profit planning, any pro-forma analysis must prepare for: a higher Mandated Minimum Rebate in Medicaid; application of Medicaid rebates to new books of public sector business; a public sector expansion will lead to rebate pressures in other markets; and a shifting of policies from one segment to another that will impact the level and volume of rebates provided.