Big Pharma's Secret Weapon: Medicare Starts to Pay Off-Quietly

Pharma companies say Part D is a simple trade: increased volume in exchange for decreased prices. Six months into the program, the deal is working out very well for manufacturers—but don’t expect anyone to celebrate just yet.

By Michael McCaughan

When IMS Health released prescription data for January, a lot of people in Big Pharma companies were scratching their heads. The data showed an across-the-board jump in prescription volume in many blockbuster drug classes. New prescriptions were up; total prescriptions were up; even cash prescriptions were up.

That doesn’t sound like a problem, but the January data was not entirely welcome. First and foremost, it seemed to paint a picture that was too good to be true. Prescription volumes were growing faster than anyone could explain. No one wants to set up false expectations, either for internal targets—or for investors who track prescription data very carefully.

The second problem was more delicate. The January surge in Rx volume coincided with the launch of the Medicare Part D benefit. Everyone expected the new program to lead to increased prescription volume as more Americans have drug coverage, a phenomenon known as induced utilization.

But no one expected a sudden surge in prescription demand on January 1. At that point, most enrollees in Part D were beneficiaries who previously had drug coverage under the Medicaid program, so there was no reason to expect huge changes in use of prescription drugs. If anything, given the glitches that plagued the early weeks of the program, you might have expected a decline in scripts. (See "Part D Starts Slow," The RPM Report, February 2006 (Also see "Part D Starts Slow" - Pink Sheet, 1 Feb, 2006.).)

It certainly wouldn’t have been bad news for manufacturers if script volumes did surge unexpectedly under Part D. The catch is that critics of the program might have been even happier. Opponents of the legislation—and nearly half the members of Congress voted against the Medicare drug bill in 2003—characterize Part D as a windfall for drug companies. In the struggle to get Part D off the ground, the perception that indeed Big Pharma was the biggest beneficiary could have been fatal.

In fact, the January script surge proved to be something of a mirage, a product of what IMS characterizes as "noise" in the system. "There is, generally speaking, a lot of noise in terms of prescription activity around January 1, as people change benefit plans and benefit plan designs change," IMS Management Consulting senior principal David Wierz notes. "Certainly, the implementation of Part D really increased that noise level, without any doubt."

So there clearly was no windfall in the first weeks of Part D. Big Pharma investors got that message well ahead of the first quarter earnings reports, so there were no unpleasant surprises in the numbers. (See "Part D Muddies Script Counts," The RPM Report, March 2006 (Also see "Part D Muddies Script Counts" - Pink Sheet, 1 Mar, 2006.).)

However, those first quarter reports may have obscured the picture in the opposite direction. Although there was no sudden surge in prescription activity, "it does appear that when you do take into consideration a noise level, there is some increase," Wierz says. "At least initially, it is relatively moderate."

But it is real. Based on a "preliminary" analysis of script trends for the first three months of the year, "it does appear that Medicare Part D has had an effect in terms of increasing the overall volume of prescription medications," Wierz says. IMS estimates that Part D has contributed about two percentage points to total prescription volume growth in the US.

In a US pharma market valued at $250 billion, two percentage points of extra growth is nothing to sneeze at, especially since it came at essentially no cost to manufacturers. The funny thing is, no one in industry is celebrating—at least, not publicly.

Downplaying Part D

Since the Medicare law was enacted almost three years ago, companies have downplayed any expectations of a big payoff from the bill, stressing that they expect modest volume increases to be more or less offset by downward pricing pressure.

The goal: defuse critics who claim Part D is a windfall for Big Pharma and should be replaced by a more tightly controlled, government run program.

Pharma firms have been disciplined in their communications, delivering a consistent message on the impact of Part D to different audiences. Eli Lilly & Co. CEO Sidney Taurel, during a May 10 webcast for the public policy community sponsored by the Kaiser Family Foundation, was asked directly what impact the company expects on its earnings from Part D.

His answer was the same as what Lilly has been saying to investors for months. "We have never quantified really what impact would be because there were some countervailing aspects here. For some products, probably lower prices because of the negotiating power of the health plans. For other products, a bit of an increase in volume."

However, that analysis compresses the timeline a bit. The volume increases have already arrived, as the IMS data indicate. But the pricing pressure has not. How could it? The plans are focused on enrollment and administration, and are only now turning their attention to market share movement.

The real tradeoff for manufacturers from Part D, at least for 2006, is different: how to communicate to investors realistic expectations for growth for the year, without inviting a political backlash by drawing too much attention to any short-term payoff from the new coverage.

That is no easy task. The temptation to play up Part D as a good news story for investors must be considerable, since Wall Street seems to be putting almost no value on the boost from the new benefit. (See Exhibit 1.)

It certainly isn’t surprising that Wall Street doesn’t seem to know what to make of Part D. The launch of the benefit was confusing and at times even chaotic, as beneficiaries, pharmacies and managed care plans struggled to work out the kinks involved in offering an entirely new insurance product—stand alone prescription drug plans—to millions of Americans.

So it is no wonder that analysts are having a tough time getting a read on the impact the new benefit was having on the performance of the pharmaceutical sector.

Another factor may be the division of labor on Wall Street. In the run up to Part D, the focus was on the managed care companies who would offer the benefit—and who are generally tracked by separate groups of analysts than those who follow the pharma and biotech sectors.

The relative lack of attention focused on Part D by pharma investors probably helps manufacturers with the delicate communications challenge surrounding the benefit, since it is not a burning topic on public conference calls. That means that companies have considerable leeway in how much they want to talk about Part D.

Disciplined Reports in First Quarter

When the first quarter earnings reports came out in April, Big Pharma companies maintained their discipline, downplaying any signs of impact from Part D. Companies stressed that it is still too early to talk about what the bottom-line impact of Part D will be. But the message was unmistakably optimistic.

Consider three examples:

■Pfizer Inc. Global Pharmaceutical SVP Peter Brandt: "We haven’t yet been able to pin down specifically what impact it may have already had…but it is something that we do think is going to be a slightly favorable impact for us in a couple of key categories throughout this year."

■Wyeth Pharmaceuticals president-the Americas Joe Mahady: "What we saw in the first quarter was minimally affected by Medicare." But the company "may indeed get a little bit more benefit as we go later into the year."

■AstraZeneca PLC CFO Jonathan Symonds: "We don’t feel yet that we’ve got a clear picture as to where these patients are going to end up, and what the distribution will be across our brands. So I think we are a quarter early on this one, but clearly volumes suggest at least in the short-term that Medicare has accounted for some uptick. What it will settle at, I am really not confident enough to tell you."

Other Leading Indicators

Manufacturers are not the only beneficiaries of increasing prescription volume. The first quarter reports by some of the leading retail pharmacy chains and wholesalers suggest that there is in indeed robust script growth coming from Part D.

Rite Aid Corp. and CVS Corp. both told investors that Part D is contributing to faster than expected growth in the pharmacy business. For chains, Part D is having an immediate downward impact on margins, by eliminating the high mark-ups pharmacies charge cash-paying customers. It is also increasing receivables, as pharmacies seek to iron out payment timelines with plans. But both chains said the expected decline in margins was offset by unexpectedly robust volume gains.

"The number of senior Medicare Part D scripts we filled in January and February was above our forecast, a sign that our comprehensive marketing programs, including our partnerships with United Healthcare, Aetna and Humana positioned us well for the launch," Rite Aid CEO Mary Sammons said. "We definitely are seeing a lift in sales from Medicare Part D."

CVS, similarly, was bullish about the early impact of Part D. "Early analysis of our results tells us we are seeing incremental scripts filled at CVS from Medicare Part D," CFO David Rickard said. "Utilization is up among CVS customers who now have Medicare coverage, and we’ve gained share and are seeing new customers in our store."

While it is good news for CVS to be gaining share in the Medicare population, the good news for pharma is in the first half of that statement: an increase in utilization among current CVS customers, thanks to the new benefit.

And, Rickard said, the increase does not appear to be the result of consumers holding off on filling scripts in December in anticipation of the new coverage. CVS gets two views of the impact—as the retailer filling scripts and as one of the Part D plan providers through its Pharmacare subsidiary.

"We haven’t seen any kind of rush to the drug store," Rickard said. "In fact, there are a fair number—close to 100,000 [of Pharmacare’s 400,000 enrollees] who haven’t as of the end of March gotten their first prescription."

McKesson Corp. CEO John Hammergren also offered an intriguing hint of a big impact from Part D. "We still believe it is too early to assess the impact of the Medicare prescription drug benefit on our pharmaceutical service revenues," he said. "But I will note that our drug distribution growth in our core customer base was stronger in March than in recent months."

But, he added, McKesson sees "no reason to depart from the industry’s estimates for growth in the mid-single digits." That is, Hammergren added, "for the time being."

Perhaps the most bullish sign may be the way the long-term care pharmacy provider Omnicare Inc. is positioning itself with investors: as a good bet for investors wanting to make a bet on Part D. (See "Omnicare: A Part D Pure Play?" in this issue. (Also see "Omnicare: A Part D Pure Play? " - Pink Sheet, 1 Jul, 2006.))

Better than it Looks?

Big Pharma’s message on Part D—that volume gains will be countered by price pressure—may prove true in the long run. But in the short term, there seems to be only upside from Part D.

Start with the 2%. "It does appear that Medicare Part D has had an effect in terms of increasing the overall volume of prescription medications," IMS’ Wierz says. And that impact was felt during the first three months of the program—before millions more people signed up for drug coverage in the rush to the May 15 enrollment deadline.

By IMS’ estimates, Medicare Part D was the payor for just under 15% of total prescriptions during the week of April 7. (See Exhibit 2.) CMS estimates that the Part D program is covering 3.5 million scripts per day as of June 11—more than double the number tracked by IMS in the first week of April. (See "Preparing for Year Two of Part D: CMS Puts a Premium on Stability," in this issue. (Also see "Preparing for Year Two of Part D: CMS Puts a Premium on Stability" - Pink Sheet, 1 Jul, 2006.))

For some companies, the impact is much greater: "For certain therapeutic categories, there obviously is a greater effect," Wierz notes. "Not surprisingly, the categories where you do see the greatest influence of Part D are those categories for long-term use of chronic medication." (See Exhibit 3.)

That is nice, but not out of line with the industry’s predictions of modest volume increases driven by Part D. Indeed, Wierz says, the two percentage point increase is "consistent with the initial expectations that we had."

But what about price? The architects of the Part D program certainly anticipate that competition between private drug plans offering the benefit will lead to significant pricing pressure on manufacturers, at least in crowded therapeutic categories.

However, that price pressure will only come in the long run. First, Part D plans needed enrollment. And, now that the initial enrollment rush is over, they need to demonstrate that they can drive market share movement between brands (or from brands to generic alternatives) before they can really start to drive prices down. (See "Medicare Part D Enters Phase 2," The RPM Report, June 2006 (Also see "Medicare Part D Enters Phase 2: Land Rush Gives Way to Claim Jumping" - Pink Sheet, 1 Jun, 2006.).)

At the moment, the Medicare market doesn’t look all that different from the commercial market. "Right now the prescribing patterns look pretty consistent with what you would see outside of Part D," IMS Health managed care business line manager Gerhard Gallwitz says. "What you might look for in the next year or two is, is there going to be a shift brand to brand or brand to generic?"

Assuming Part D plans do start flexing market share-moving muscle, the impact on pricing won’t be felt for some time. Contracting for the 2007 plan year is essentially complete. "In reality, pharmaceutical companies now in the second half of ’06 are really looking at the 2008 CMS planning cycle," Gallwitz say.

In fact, for many brands, the start-up of Part D meant a significant net price increase, thanks to the transfer of over 6 million people out of the Medicaid "best price" rebate market into the new Part D market. (See "Dueling for Duals," The RPM Report, January 2006. (Also see "California Court’s Inaction On TiO2 Prop 65 First Amendment Case Breeds New Lawsuits" - HBW Insight, 24 Apr, 2024.))

Discounts Pay Off

AstraZeneca’s blockbuster proton pump inhibitor esomeprazole (Nexium) may be the best indicator of how the price versus volume trade-off is working under Part D so far. Nexium is the kind of product expected to face intense pricing pressure under Part D, since it competes in a crowded category and there is a close chemical cousin—omeprazole—available as a generic prescription and over-the-counter.

Nexium was frequently singled out by Tom Scully, the former head of the Centers for Medicare & Medicaid Services, as a product that payors—including the federal Medicare and Medicaid programs—should not cover.

So far, though, the launch of the Medicare program has had the opposite effect. Nexium was the fastest-growing brand in PPI market, with prescriptions up 18%.

AstraZeneca did pay a price for that volume: price concessions kept dollar growth below the script volume, but the product was still up 14% in sales—more than double the PPI market growth.

Prudential Equity Group analyst Tim Anderson predicted the strong quarter for Nexium ahead of AstraZeneca’s report.

He says AstraZeneca saw the potential price boost from the transfer of "dual eligibles" and used it to good advantage. "Although AZN has said for the last few quarters it has been rebating to an increasing degree to capture preferred formulary positioning, the ‘dual eligible’ aspect of Part D is likely to reverse much (if not all?) of this," Anderson said. The company "may have made the strategic bet last year to contract more favorably with Medicaid to capture these ‘dual eligibles’ once they rolled over to Part D in 2006."

Anderson also correctly predicted that AstraZeneca would not dwell on the pricing issue in its first quarter report. "The ‘dual eligible’ impact to Nexium and other affected products, such as Seroquel, should continue throughout the remainder of 2006. The drug industry generally appears to be playing down the impact of ‘dual eligibles’ probably to stay beneath the radar of Congress and others, and AZN is likely to do the same."

Forest Laboratories Inc. is in a similar position as AstraZeneca with the follow-on antidepressant escitalopram (Lexapro)—a close chemical cousin of the off-patent SSRI citalopram (Celexa). Indeed, when the Centers for Medicare & Medicaid Services directed Medicare prescription drug plans to cover all brands in the antidepressant class, the agency specifically excluded Lexapro, saying plans could cover either escitalopram or citalopram. (See "Lexapro: The First Victim of Part D?" The RPM Report, December 2005 (Also see "Lexapro: The First Victim of Part D?" - Pink Sheet, 1 Dec, 2005.).)

Forest has been discounting Lexapro more deeply—the company said it expects its average discount on the drug to come in at about 17% during the current fiscal year, up from 16% in the fiscal year ended March 30.

However, Forest expects Lexapro to keep growing at above-market rates—both in scripts and in dollar terms. "We project an increase in overall prescription volume for the underlying SSRI/SNRI antidepressant market as a whole of approximately 2% and an increase in Lexapro's total prescription market share of between 25 and 50 basis points," the company said. "This increase in market growth as well as market share, along with a price increase, is projected to generate Lexapro sales of approximately $2.07 billion, growth of 10-11% from the reported sales in the just completed fiscal year."

Not All Good News

Not all the news from Part D is good. The rocky start to the program meant in many cases that beneficiaries who were previously covered by Medicaid had difficulty refilling prescriptions in January—the main issue that fueled headlines about start-up "glitches" in the early weeks of the new benefit.

Some pharma executives are concerned that many of those patients may have discontinued therapy altogether after encountering the program.

Beyond that, the factors that should drive increased utilization under Part D do not apply to the Medicaid population. These "dual eligible" beneficiaries already had generous drug coverage under Medicaid. In fact, the Part D coverage may be less generous in many cases. Under Part D, plans can charge a copayment of up to $3 on brands. The Medicaid copayment was typically lower and was routinely waived by pharmacies.

One executive at a pharma company sees evidence that, indeed, the Part D script trends are not as robust in the former Medicaid population. The executive cites first quarter prescription data for the company’s most important brand, where trends vary markedly by zip code. In Fort Myers, Fla., script trends soared—likely reflecting the addition of drug coverage for relatively well off Medicare beneficiaries. But in a nearby Miami zip code—where most Medicare beneficiaries were already covered by Medicaid—growth actually seems to have slowed.

But the bottom line is still positive. Overall, the executive sees a boost from Part D for the brand. It’s just that the picture could be even brighter if the script trends among former Medicaid beneficiaries were not being held back.

Other Transition Issues

For other brands, the transition to Part D was unequivocally negative. Kos Pharmaceuticals Inc. , for example, missed out on the growth of the cholesterol-lowering class because its sustained-release niacin product Niaspan was initially excluded from the program altogether.

By law, Medicare Part D does not cover prescription vitamins, and CMS decided that sustained-release niacin should therefore be excluded. The agency reversed its position in April—too late for Niaspan to benefit in the first quarter. (See "CMS’ Change of Heart: Niaspan Will Be Covered Under Medicare Part D," The RPM Report, May 2006 (Also see "CMS' Change of Heart: Niaspan will be Covered Under Medicare Part D" - Pink Sheet, 1 May, 2006.).)

"Because of this, we were not able participate in the obvious first quarter growth of the lipid market," Kos CEO Adrian Adams said. "Part D we believe actually had a positive impact on the prescription trends in the chronic disease area. If you look at the trends in the cholesterol market more specifically, we saw an increase in growth of that market as it moved into the first part of this year."

"Because of this CMS decision, we were not able to participate in that growth. In addition to that, some of the patients that were on Niaspan…started to switch to other brands," Adams said. "We believe, that is one of the reasons why our prescription trends here in the first quarter of this year were softer than anticipated."

Kos expects that to change. "Having a positive decision from CMS…we are obviously optimistic that prescribing trends will get better."

The transition to Part D has also been difficult for one of the industry’s blockbuster brands: Wyeth/Amgen Inc. ’s TNF inhibitor etanercept (Enbrel). Growth of the drug actually slowed in the first quarter—not the outcome most predicted given the potential for Part D to pick up the bulk of the $10,000 plus annual cost of the product.

Amgen attributed the difficulties to two issues. First, Johnson & Johnson adopted a discounting strategy for its TNF infusion agent infliximab (Remicade), which continues to be covered under Medicare Part B. Remicade’s resulting share gain is a strong indication that Part B coverage continues to be an attractive setting for high-priced therapies. (See "Mind Your Bs and Ds," The RPM Report, June 2006 (Also see "Mind Your Bs and Ds" - Pink Sheet, 1 Jun, 2006.).)

Enbrel was also hurt by the start-up glitches in Part D, Amgen says. The biologic therapy was covered by a temporary program launched in 2004 as a precursor to Part D. During the fourth quarter of 2005, Amgen says, physicians stopped enrolling patients in that program in anticipation of the launch of the full benefit. But then Part D started slowly—giving J&J another opening to capture share while patients decided whether and how to enroll in the new coverage.

From the perspective of Part D plans, the more patients who choose treatment with Remicade (and bill Medicare Part B—not the Part D insurer—for the cost) the better. Nevertheless, Amgen remains optimistic that Part D will pay off for Enbrel.

Amgen’s openness about the difficulties faced by Enbrel illustrates another reason why Wall Street may be underestimating the payoff from Part D for Big Pharma: while manufacturers have strong incentives to downplay the upside of the new benefit, they have no reason to hold off on blaming Part D for underperformance.

Enbrel’s other competitor in the TNF inhibitor market, Abbott Laboratories Inc. ’s self-injected, Part D covered adalimumab Humira, grew at more than double the rate of Enbrel in the first quarter. In other words, J&J’s contracting strategy and the disruptions surrounding the Part D program launch January 1 didn’t seem to hurt that product. That has left some analysts wondering whether Medicare really is the explanation for the slowdown in Enbrel.

"Positive in All Ways"

There is no reason to expect pharma companies to change their tune on Part D anytime soon. The consequences of gloating would be too dire. Plus, since a rising tide lifts all boats, firms may be happier discussing issues where they see specific advantages over competitors or the rest of the industry as a whole.

But the impact will be hard to miss as 2006 moves on. Look at Pfizer: the company has been clear about seeing Medicare as a potential positive, but like everyone else, downplays the impact. Wall Street is focused on other issues: in Pfizer’s case, the launch of a generic version of Merck’s blockbuster statin simvastatin Zocor, and the potential form managed care companies to try to move the market away from Pfizer’s top selling brand atorvastatin (Lipitor).

However, one of the company’s key predictions heading into Part D looks like it is coming to pass. Lipitor’s allure for consumers gives Medicare plans an incentive to cover the drug in order to attract—and retain—enrollees. In fact, according to Pfizer, Lipitor’s formulary position is stronger under Part D than in the commercial market.

So if there is big push for therapeutic substitution in the statin category, it will be coming in the commercial market in 2006, and Part D can’t be blamed for that. Indeed, the positives of Part D may be enough to help Pfizer ride out any bumps associated with the launch of generic Zocor.

That may not change the picture for the long term. Over time, plans will try to extract deeper discounts from Pfizer to maintain favorable formulary positioning, or adopt more aggressive management tools like step therapy in the statin class.

But there are no signs of that so far. No wonder Pfizer is starting to sound more bullish about Part D, at least behind closed doors. Prudential’s Anderson, in a recent note from a meeting with Pfizer management, summarized the company’s statements about the new drug benefit succinctly: Pfizer "generally said that the new Medicare Part D program is essentially positive in all ways."