Investor's Business Daily, March 22, 2004

Controversy Is Hotly Debated; Even drug makers, analysts can't agree on whether law will bring big pharma profits

Recent controversy over the true cost of the new Medicare prescription-drug plan reignites another dispute: Where will the money go?

The bill earmarks $400 billion for new prescription-drug benefits over the next eight years. A much-quoted study by two Boston University scholars, released last fall, argues that around 35% of that -- or $139 billion -- will head straight to drug makers' profit columns.

The reason: With more money available to spend on drugs, people naturally will buy more.

Or maybe not. The drug makers themselves -- as well as analysts and other industry insiders -- don't agree the law will bring such a bonanza.

The Pacific Research Institute recently employed two PricewaterhouseCoopers consultants to scrutinize the Boston University study and come up with their own estimate.

Consultant Jack Rodgers presented the team's findings to an industry conference earlier this month. He says the conference wasn't impressed with methods used in the Boston University study.

"The people in the industry were almost laughing," he said. "They had enough knowledge to know that level of profit was kind of silly."

Rodgers and co-author John Stell released their findings on March 4. Their profit estimates -- ranging from a 3.2% increase to a 1% decline -- were wildly at odds with those of the first study.

There were many points of dispute between the two studies. But the biggest gap involves two issues: how much the new law will heighten demand, and how much competitive pressure it will bring.

Rodgers and Stell cited a Rand Corp. study from the 1970s showing that changes in health insurance coverage don't have a big impact on how much people spend on medical supplies and services. People regard health spending as a necessity more than a luxury, Rodgers says.

"Everybody uses some drugs," he said.

But Alan Sager -- who co-authored the Boston University study with Deborah Socolar -- has a different take. He says the Rand study doesn't really work as a future model for Medicare. Its subjects' health insurance was structured differently, and many of the premium drugs that patients want today didn't exist during the '70s.

In addition, many drug companies advertise heavily today. That might lure more users.

As for the idea that competition will drive down prices: People said the same thing about health-maintenance organizations in the early 1990s, Sager says. But health costs are higher than ever.

He also charges that the new law fragments the buying power of health insurers and pharmacy benefit managers, so there won't be much price pressure on drug makers. Normally those middlemen bargain for the best price, leading drug makers to offer rebates on some of their products .

Even if drug rebates go up, Sager says, this would ultimately increase demand for drugs -- and create more revenue for drug makers.

"No matter what the discount, the money ends up going back to manufacturers," he said.

Rodgers and Stell point to Congressional Budget Office estimates saying that savings on drug prices will increase by 10% in the new prescription-drug plans. Presumably, those savings will go to consumers.

They argue that because the new law will create multiple drug plans, the drug plans will have to compete on price. This should drive the average rebates from 14% of total drug industry revenue to as high as 20%.

In any case, no one will know for sure who's right until after 2006, when the new prescription-drug plans go into effect.

"We'll be seeing what the plans will offer when they come out," Rodgers said.