C:\can files\2003junepharmaceuticals.wpd

Stuart J. Sweet, President
June 6, 2003
With the tax cut fight behind us, Washington’s attention has turned to the pharmaceutical industry. Next Thursday, the Senate Finance Committee is expected to begin publicdeliberations over how to structure an outpatient pharmaceutical benefit as part of the Medicareprogram. The House Ways and Means Committee and the House Energy and CommerceCommittee also should begin the formal design process a few days later. If all goes as GOPleaders plan, before the month of June is over, both the full House and the full Senate will bedebating on the floors of Congress detailed legislation on how to best spend $400 billion or moreover ten years to help Medicare beneficiaries with their drug bills. A $400 billion federalsubsidy will pay for 20 percent of all projected senior pharmaceutical consumption. It’s possiblethat the total will exceed $400 billion, but only if offsetting spending cuts or tax increaseselsewhere are adopted, such as boosting customs fees.
As the Committee drafting process gets underway, the dominant idea significantly expands the private insurance market, with a senior pharmaceutical policy having four designelements: Seniors who elect to purchase subsidized insurance would pay modest monthly premiumsof $33 to $35 and also pay modest annual deductibles of $250 to $275. After breaching the deductibles, private insurers would pick up 50 to 80 percent ofadditional drug costs until a limit is reached. Above the limit, seniors would pay 100 percent until they reach a second, and final,catastrophic ceiling. Above the catastrophic ceiling, insurance would again pay 90 to 100 percent. The federal government would pay insurers to offer this product. Furthermore, the federalgovernment also would pay some or all of the premiums for seniors with incomes up to 175percent of the poverty line. Those below the poverty line already receive assistance under theMedicaid program.
Who Pays What – and How Big Is the Donut?
Late Thursday, the leaders of the Senate Finance Committee, Chairman Chuck Grassley (R-IA) and Ranking Democrat, Max Baucus (D-MT), announced they had reached agreement ona Medicare reform plan that offer significant outpatient pharmaceutical assistance to seniors. These two Senators wield considerable influence with their Committee colleagues. Consequently, investors can assume that the full Committee will approve their compromise withfew modifications. The full Senate can be expected to debate their plan soon thereafter. Thefollowing table compares the Finance Committee leaders’ plan with what the House passed last year, which the Ways and Means Committee is considering carefully again this year. As thefollowing table shows, the primary difference in the plans are co-payment rates and the size ofthe “donut” – the term used to describe the zero coverage range just below the 90 to 100catastrophic coverage. Since the House plan would require insurers to pay 80 percent ofamounts between $251 and $1,000, it has to be less generous above $2,000 to stay within the$400 billion budget.
Comparing House and Senate Medicare Drug Proposals
It is not necessary for aggressive investors to wait any longer before making plans on how to respond. Enough is known. The key question to answer is – how will senior react tothese types of plans? What’s the Best Health Care Somebody Else’s Money Can Buy?
Like all consumers, seniors will buy more pharmaceuticals when they pay less out of their own pockets. On April 20,2001 Jack Hoadley, an analyst working for the U.S. Departmentof Health and Human Services quantified this impact on pharmaceutical purchasing by analyzingofficial data. He published the following chart. 1998 Drug Spending
Medicare Beneficiaries, by coverage
No coverage
Medicare HMO
Other coverage
Type of Prescription Drug Coverage
Insurer Spending
Out-of-pocket spending
Source: U.S. Department of Health and Human Services Capitol Analysts Network, Inc.
It shows that seniors without health insurance spent an average of $562 per capita onpharmaceuticals in 1998. Those with insurance consumed between $682 and $1,213, dependingon the coverage they held. Seniors who lack insurance now, and who now spend more than $250on pharmaceuticals, also would buy more when an insurance company is picking up fifty toeighty percent of the tab for purchases above $250.
There is anecdotal evidence that some seniors take less than the optimal amount of medicine prescribed by their doctors to save money. If they are supposed to take hypertensionmedicine twice a day, they may take it once a day, for example. Sales on hypertension medicineare likely to rise when uninsured seniors become well insured. However, most seniors won’tbreak doctors orders when it comes to medicine that keeps them alive; this phenomenon isunlikely to be common among those suffering from cancer, serious heart disease, or diabetes.
What accounts, therefore, for Hoadley’s findings that pharmaceutical consumption risessignificantly when patients have insurance? It can’t be due to soaring cancer medication sales.
It appears that seniors primarily expand their purchases of drugs that improve the quality of life, rather than purchase more life-sustaining drugs, when they become covered by significantinsurance. The plans being weighed by the key congressional Committees most resembleMedigap policies. Those plans also have 50 percent copayment requirements. If so, then newlyinsured seniors may respond similarly, and boost their purchase of pharmaceuticals by a similarpercentage, 68 percent.
How Much Will This Buying Surge Help Industry?
According to Congressional testimony submitted by John Poisal, a statistician with the Center for Medicare and Medicaid Services, 54 percent of Medicare beneficiaries already havepharmaceutical insurance coverage; another 19 percent have coverage part of the year, while 27percent have no coverage http://www.medicaid.com/media/press/testimony.asp?Counter=624 .
A lower estimate of the buying surge can be derived by assuming that only the 27 percentwithout any coverage will switch to the new, Medigap-comparable, federally, subsidized plan. Ifthis subpopulation also buys 68 percent more in response to having insurance, then total seniorpurchases will rise by 18 percent (0.68*0.27). A ceiling can be calculated by assuming that allthose lacking full-time coverage switch over, or 46 percent of seniors. If this group also buys 68percent more, then the total increase will be 31 percent (0.68*0.46).
The American Association for Retired People (AARP) estimates that Medicare beneficiaries in 1999 generated 40 percent of U.S. prescription spending. If this group now buys18 percent to 31 percent more because of federally subsidized insurance, then total national salesto all patients will grow by 7.2 percent (0.40*0.18) to 12.4 percent (0.40*0.31). Perhaps thisexplains why pharmaceutical companies have been discreetly silent to date as the debateescalates. We are unlikely to see a repeat of the “Harry and Louise” television commercials. If you want to reconfigure your investments to benefit from the possible seniors buying surge, a good starting point may be to review a list of quality-of-life improvement drugs that are Capitol Analysts Network, Inc.
now sold to them. This CAN analysis includes such a list, sorted by company, and dollarvolume, as an appendix. Factories making these drugs may have to put on additional shifts tomeet additional demand. Insurance likely will go into effect on January 1, 2006.
O Canada!
There is another little discussed reason why drug companies support the GOP plans. It will put an end to grandma’s drug smuggling. On May 8, 2003, the Washington Post quotedFDA Commissioner Mark McClellan as stating that unauthorized cross-border sales, mostlydone with Canadian counter-parties, amount to 1 to 2 percent of all drug sales. In the samearticle, a spokesman for The National Association of Chain Drug Stores estimated that such salesare growing at a remarkable 50 percent annual clip.
Grandma smuggles because Canadian prices for pharmaceuticals are an average of 40 percent cheaper there than in the U.S. because of price controls. No doubt grandma would preferto buy her medicine from local pharmacists rather than risk consuming faulty products fromlargely unknown Canadian sellers, and she would do so if prices were comparable. If she hadGOP-style insurance, this would be the case. Instead of buying hypertension medicine fromBritish Columbia for $100 a month, for example, she could buy it for $180 down the street, and –after a 50 percent copayment – pay only $90. Notice, however, that the price received by theretailer has gone up from $100 to $180. Much of that $80 increase will filter back to thepharmaceutical manufacturers. If one million grandmas change their ways, annual drug profitscould grow by $1 billion to $3 billion. Probability of Congressional Action
CAN estimates there is a 65 percent chance that Congress will pass a Medicare drug benefit this Congress, perhaps as early as this summer.
For further analysis or information, contact Capitol Analysts Network, Inc. at: 2003 Capitol Analysts Network, Inc. All rights reserved Capitol Analysts Network, Inc.
Appendix A: Quality-of-Life Drugs that Doctors Often Prescribe for Seniors
2000 Sales
(Trade Name)
Ditropan XL
Megace Oral Susp
Wellbutrin SR
Sources: Pharmacy Times 2001; Families USA; Department of Health and Human Services
Capitol Analysts Network, Inc.

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