Medicare Part D: D for Doomed?

The early warning signs are clear.

Implementing the Medicare Modernization Act (MMA) is not proceeding as smoothly as many expected. The government appears to have severely underestimated its expenses, and Part D will likely far outstrip all original cost projections. At the same time, seniors are staying on the sidelines. Enrollment remains far below expectations. Almost as troubling as the lack of patients: a surplus of Part D plans. The vast array of coverage packages seems to have confused many potential beneficiaries.

More plans with lower enrollment per plan have cut the bargaining power—and perhaps the profitability—of individual plans.

A recent Wall Street Journal/Harris Online survey showed that only one in five respondents 65 and older believe the program will make prescription drugs more affordable, while fewer than half said they are likely to sign up for the program. And although enrollment has picked up lately, the latest figures still suggest that only 5.4 million of the 22 million remaining beneficiaries have enrolled voluntarily in a Medicare drug plan or a Medicare Advantage plan, according to the Associated Press.

Costs are already escalating, mostly because of implementation problems. A February 2006 report by the Kaiser Family Foundation found that 37 state governments have been forced to guarantee or pay for drug coverage for "dual eligibles" not yet covered by Part D programs.

Under the Influence: What Shapes Part D?

Beneficiary dissatisfaction has ignited political blowback. Congress fears resentments from senior citizens, so political factors are likely to shape government reaction to cost over-runs and beneficiary discontent. Budgets are tight in Washington. War costs billions each year, and billions more must be found for hurricane relief. Part D is a Republican program. If things go badly for the Republicans, might the Democrats gain control of either the House or the Senate in 2006? Or the White House in 2008?

Each of these variables is important in its own right, but beneficiary enrollment and program costs are the most critical. Beneficiary enrollment determines the number of health plans that will survive in the market. At the same time, the cost of Medicare Part D drives the political debate—and the policy options—that will determine the future of the program. What happens if enrollment remains low, or if costs spiral out of control?

Let us examine two hypothetical scenarios about how the Medicare Part D market may evolve. These are based on historical precedent—in particular, the experience of other government health insurance programs—as well as the available evidence of current beneficiary attitudes toward the program. These scenarios are not intended to forecast or predict how the Part D marketplace will evolve. Instead, they are meant as plausible, realistic scenarios to illuminate the key market drivers, their impact on the Part D market, and implications for the pharmaceutical industry.

Scenario #1

Low voluntary enrollment does not mitigate financial risk. Due to confusion about the program and widespread implementation challenges, voluntary enrollment falls significantly below expectations. A disproportionate share of the enrollees come from the high-cost, dual-eligible population, whose members are automatically enrolled in Part D plans by state Medicaid programs. With enrollment low, many Medicare Advantage Prescription Drug Plans (MA-PDs) and Prescription Drug Plans (PDPs) are unable to sign up enough beneficiaries to manage risk and earn a reasonable profit—even with government subsidies. Many plans leave the market, and the federal government is forced to rely on fallback plans in some regions. In other regions, beneficiaries find themselves with extremely limited plan options. Dissatisfied with their choices, beneficiaries drop out, and voluntary enrollment rates decline further.

The low enrollment rate leads opponents of privately administered approaches to Medicare prescription drug coverage to advocate for a centralized, government-run system. In an attempt to appeal to the powerful senior-citizen voting bloc in advance of the 2006 and 2008 elections, politicians from both parties agree to major reforms to centralize control of Medicare Part D, streamline its cost structure, and ensure availability of resources and benefits to enrolled beneficiaries. Reforms eventually result in decisions, such as the adoption of one national formulary, to decrease the prescription drug program expenditures and, hopefully, encourage beneficiary enrollment.

How realistic is such a scenario? Here are a few facts that point to such an outcome:

Voluntary beneficiary enrollment has been far below expectations to date. More troubling, government estimates of the number of eligible and enrolled patients changes with the assumptions used. For example, the Boston Globe points out that the government includes the following groups as Medicare enrollees even though their enrollment is not directly voluntary:

• 3.1 million military and federal government retirees who received comprehensive drug benefits before the start of the Medicare plan

• 6.4 million retirees who received drug benefits from their former companies or unions

• 4.5 million people who already had drug coverage through Medicare Advantage plans

• 6.2 million dual eligibles.

Implementation issues have led to frustrated beneficiaries and public constituents, and may further dampen future enrollment. In many instances, enrolled beneficiaries were not earmarked with the correct level of co-payment, deductible, or benefit coverage. Some paid substantially more than their plan dictates. Plan systems are not up-to-date on the approved drug list, and pharmacists are having difficulties approving enrolled beneficiaries with private plans. And as the Kaiser study documents, states have to pick up the financial slack when the federal payment program fails.

Medicare is losing its potential negotiating power by allowing private insurers to negotiate with drug companies directly. According to a study conducted by Families USA, the Veterans Administration (VA) offers better drug prices than private plans for 19 of the 20 medicines examined. In addition, the VA discounts were two to three times greater than the private plans.

Highly publicized failures of the private sector in recent years have led the public to support a wider government role in the marketplace. Private companies have failed to provide crucial elements of the "social safety net," including affordable health coverage and pension benefits—leading many to support a broader public role in these areas. When the private sector failed to safeguard airports, the federal government took over.

A similar situation is developing with the Medicare drug benefit. As the MMA implementation limps forward, and beneficiaries become frustrated with the benefit structure and access, constituents may demand more federal involvement. So the federal government may have to take a proactive oversight role, even as it collaborates with the private sector.

Strong beneficiary enrollment is necessary for the current approach to Medicare Part D to succeed. Failure of the market-oriented approach could strengthen the hand of those who have been opposed to that approach from the beginning. In the current political climate, with the Republicans weakened and the 2006 midterm elections approaching, advocates for a centralized government program may gain the upper hand.

If this were to happen, the impact on the pharmaceutical industry could be severe. For example, if the government were to implement one national formulary, pharmaceutical companies would face enormous pressure to achieve a favorable position on that formulary. A vicious cycle of discounting and rebating to ensure formulary placement might lead to a downward spiral in pharmaceutical prices. This has been the end result of other government-run health programs, such as Women, Infants and Children (WIC).

In "Out of the Mouths of Babes" (Pharm Exec, September 2004), Mason Tenaglia recounts the effect of WIC on companies that started out with healthy market share and a profitable business. He describes the slippery slope from what began in the early 1990s as an innocent increase in baby-formula rebates to an all-out price war, in which major manufacturers—Abbott, Wyeth, and Bristol-Myers Squibb—cut their profit margins to the bone in an effort to win government contracts. Depending on how strong the government role in pricing becomes, a similar scenario could play out in the Medicare drug benefit.

Scenario #2

Costs far exceed original projections, even though enrollment is strong. Enrollment meets or exceeds expectations, but costs per beneficiary skyrocket under lax cost control by private plans (which increase benefits to attract enough beneficiaries to remain in business). Cost overruns affect federal priorities, and the government becomes unwilling or unable to fund this program. Commitments to war and disaster relief place strong pressures on an administration that prizes tax cuts for individuals.

Cost-conscious politicians clamor to let the Centers for Medicare & Medicaid Services (CMS) negotiate drug prices directly with manufacturers. This movement gathers political momentum as proponents cite successes: drug prices negotiated by the VA's Federal Supply Schedule (FSS) and by state Medicaid programs. In a pre-election appeal to the powerful senior-citizen voting bloc, politicians from both parties agree to major reforms, including centralized negotiating power for CMS.

How realistic is this scenario? Government programs—particularly entitlement programs—are notorious for cost overruns. Once again, the WIC experience illustrates how programs exceed cost estimates. When the program was introduced in 1983, it was designed to provide the poorest 20 percent of mothers with free infant formula. But, as qualificaton standards became more liberal, the program eventually escalated to cover 50 percent of all newborn children in the United States. As the enrollment rate increased, government asked for bigger discounts, which eroded pharma's margins. Slowly, the program became unsustainable.

Many Democrats support giving CMS power to demand lower drug prices. In the 2004 presidential election, Democratic nominee John Kerry advocated scrapping the privately run approach and centralizing bargaining power in CMS. In September 2005, Senator Ron Wyden (D-OR) championed an amendment to the 2003 MMA legislation giving CMS the power to negotiate prescription drug prices for Medicare. The amendment did not pass, but it showed that many politicians would happily grant such power to CMS.

The Bush administration is already exploring ways to control Medicare costs in Parts A and B. In his 2007 budget, President Bush has proposed cuts in payments to hospitals and nursing homes for Medicare patients, as well as higher premiums for high-income Medicare beneficiaries. The President cited the aging of the baby boomer generation—with its implications for continued high costs—as the rationale for these measures. This same argument holds for Part D.

Even if Part D enrollment is strong, cost overruns may spur major Part D reforms. With yawning budget deficits and rising pressure from all sides of the political spectrum, the government may consider a centralized approach to Part D.

Support for Senator Wyden's amendment demonstrated that critics of the current Part D program believe centralized bargaining power reduces costs better than competition between private plans. These arguments gain ground if costs exceed projections.

As in the first scenario, pharmaceutical profit margins will be reduced if CMS exerts centralized control over Medicare Part D—especially if CMS is granted the authority to negotiate prices directly with pharmaceutical manufacturers. Other government health insurance programs, such as VA/DoD (Department of Defense), state Medicaid programs, and Medicare Parts A and B, show how much downward price pressure the government exerts.

What's a Pharma Company To Do?

The rocky start to the Medicare Part D program, coupled with the potential for power shifts in Washington in 2006 and 2008, increase the likelihood of further Medicare reform. There are some key steps that pharma companies should take now to prepare for the possibility that Medicare formularies grow more rigid, and CMS takes control of price negotiations.

Use scenario-planning exercises to better understand the risks and opportunities of further Medicare reform. These exercises can help companies elucidate the range of potential reform scenarios, and quantify the bottom-line impact of each. The exercises also can be used to identify which brands face the highest risks in each scenario, and to develop strategies to mitigate those risks.

Lobbying efforts have so far produced Medicare reforms that are favorable to pharma. Now, the industry can help its cause again by marshalling the facts to support the case, and by forging alliances to ensure that decision makers and the general public hear pharma's voice in the debate.

With initial enrollment in the Part D program just ending, pharma must watch the variables that drive changes in the Part D marketplace. This will allow companies to begin anticipating what the future holds for Medicare prescription drug benefits in this complicated new environment.

Wendy Huang and Jason Pesile are managers, and Mark Mozeson is the practice leader in the global life sciences practice at Archstone Consulting. They can be reached at whuang@archstoneconsulting.comjpesile@archstoneconsulting.com and mmozeson@archstoneconsulting.com