As if pharma shares needed any more uncertainty, it is looking like the best case scenario for the world’s largest drug purchaser may be a 2% cut to its buying power. Details of the austerity measures that have filtered out of the fog of to-the-brink negotiations on raising the US government’s debt ceiling suggest sharp rein on Medicare reimbursement to plans and providers, which in turn will make them even more tight-fisted when it comes to buying medicines.
More detail will not emerge until late autumn as a special legislative committee considers options to trim federal spending by $1.5tn in the next decade. Should those talks fail, automatic reductions of 2% to the government programme for senior citizens will be triggered. However, what some investors fear is any agreement that achieves those savings goals will potentially contain even deeper cuts to Medicare.
There is some scepticism as to whether the special committee can succeed where Congress and President Obama have so far failed, which is why the automatic Medicare spending cuts have figured so prominently in assumptions about the budgetary endgame.
In the absence of positive congressional votes on spending reductions as recommended by the committee, the debt limit law triggers across-the-board budget cuts for many government accounts at a level that will achieve the goal; however, reductions will be capped at 2% for Medicare, which is forecast to spend $3.2tn between now and 2020, according to US government projections.
The mechanics of how the 2% cuts would be imposed are somewhat vague. The belief is that fees paid to hospitals, doctors and health plans would be trimmed by that amount, which in turn will affect pharma and biotech companies by reducing the dollars that health plans have to pay for pills at the pharmacy.
Reimbursement to physician practices for drugs administered in the office would also likely be cut; likewise, hospitals would likely see reductions to their per-case payment rates, which bundle in many drug costs, so they too would have would have constrained pharmaceutical buying power.
This paints a predictable if unhappy picture for many pharma investors, in that 2% is a number that can be modelled and forecasted, which in many ways makes it a best-case scenario. A more uncertain future, however, lies in the proceedings of the special committee, a numerically balanced panel of members from both parties and both houses of Congress which have the potential to result in even deeper cuts to health care programmes.
Analysts at ISI Group note that possible pharmaceutical-related cuts could include the extension of best-price rebates now commanded by state Medicaid programmes to include Medicare beneficiaries – the average Medicaid rebate is 23.1% from wholesale acquisition cost.
If that idea were to become law, analysts from Bernstein Research estimate earnings-per-share reductions of between 2% and 6% for big pharma companies in 2012, depending on Medicare exposure: Eli Lilly would see a hit of 6.3% at the high end, GlaxoSmithKline 2% on the low end.
This idea is more popular with Democrats than Republicans. Conservative Medicare reforms more popular with Republicans, on the other hand, have more to do with giving beneficiaries vouchers to buy private coverage. The Bernstein analysts note that whilst this would have no direct effect on pharma spending, it would likely reduce overall per-beneficiary health care spending and the number of enrolees in insurance plans, with gradual reductions in demand for drugs.
These are two rather drastically different views of the future of US health care. Given the makeup of the committee, it is hard to see a compromise emerging, meaning an automatic 2% cut to Medicare is the most likely outcome.