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.

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.com
jpesile@archstoneconsulting.com
and mmozeson@archstoneconsulting.com