Thursday, April 22, 2010

Lilly's $1 Billion Investment in Health Care Reform (Part One): It's All About Zyprexa

With our unerring sense of timing, we just published an analysis of the health care reform bill explaining our view that the biopharmaceutical industry did really well under this law, even better, in fact, than we thought they would do when reform was all but done in January.

Then Lilly announces some rather astonishingly large cuts in its 2010 and 2011 revenue guidance--due to health care reform. This year, Lilly says, revenues will be down $350-400 million, and next year the hit will be bigger, $600-700 million. (You can read more in “The Pink Sheet” DAILY.)

Altogether that makes a $1 billion hit from reform. This is good news?

Ah, but it is. Really.

And we figured we should explain our thinking one more time, in the context of Lilly’s announcement (and the wave of follow-up guidance adjustments from biopharma companies big and small).

First off, it bears repeating that the reform bill is, by design, front-loaded on pain and back-loaded on gain.

Medicaid rebates increase this year and market share fees begin next year. Expanded insurance coverage doesn't really kick in until 2014. Industry knew what it was getting into when it decided to support health care reform: there would be a price paid up-front in order to see the new business from insurance expansion later on.

In other words, it isn’t so much a hit from health care reform, as it is an investment in a bigger US market. And we think the math works out wonderfully.

Now, bear in mind that Lilly is probably the company most affected by the front-loaded pain of reform, thanks almost entirely to its extraordinary Zyprexa franchise. The company, in effect, is a victim of its own success in holding the line on prices for its biggest brand.

Zyprexa was at one time almost exclusively covered by Medicaid (estimates were at least 70% of US sales). That profile meant that Lilly had no reason to engage in deep discounting in the commercial market, which would have meant deeper rebates to Medicaid under the “best price” rebate formula. So Lilly presumably paid the minimum rebate (15.1%).

The health care law sets a new minimum rebate amount (23.1%), which in effect increases the size of Lilly’s base rebate payments by about 50%. That probably explains most of the $350-$400 million impact in 2010. (The new law also applies rebates to the Medicaid managed care market; while that isn’t as big an impact it is still pretty big—in essence an increase from zero rebate to 23% or more for the Medicaid managed care sector.)

Other manufacturers probably aren’t as exposed to the change in the minimum rebate amount. Pfizer, for example, is about 50% bigger than Lilly in the US, but its product line is not as heavily covered by Medicaid in the first place, and its biggest product—Lipitor—is discounted in the commercial market and so probably already generates a rebate payment at or above the new minimum. (There will still be an impact on Pfizer, of course, but we won’t know how much until it reports in May.)

Don’t feel too bad for Lilly, though.

The relatively big impact on Zyprexa is primarily a function of the company’s success in staving off earlier efforts to extract deeper discounts on the brand. As Zyprexa’s impact on Medicaid grew early in the 2000s, many states tried to impose supplemental rebates on the brand. Those fights were starting to become more difficult when the Medicare Part D legislation came along, and as of Jan. 1, 2006, at least half of the Medicaid population switched to the new Part D coverage.

That meant an end to the push for supplemental rebates. It also meant a de facto one-time price increase on the brand, since Medicaid rebates also capture an inflationary price adjustment. In fact, Lilly and Zyprexa were probably the biggest beneficiaries from the launch of Part D in 2006. (See “Lilly Makes Part D Pay,” The RPM Report, January 2006.)

All of which underscores another point to remember when considering the estimates of the cost of health care reform: the alternative to the upfront hit from reform would almost certainly be a different sort of hit. So, for Lilly, the higher Medicaid rebate at least helped stave off the push to reclaim the Medicaid rebates on the Part D population.

There is no way to know for sure as an outsider, but we believe the hit from dual eligible rebates would have been bigger for Lilly than the hit it is taking now. All the more so if the dual eligible rebate were enacted solely as a revenue measure, not as part of comprehensive health care reform.

And it is possible to put a little context around the number. $1 billion is less than one-quarter's worth of Zyprexa revenues, and it is also less than the $1.4 billion Lilly paid to settle marketing investigations related to the product in 2009.

Then there is the matter of timing. Lilly sees a huge revenue hit in 2010 and 2011 from health care reform, but of course the bigger hit will come from the patent expiration for Zyprexa itself at the end of 2011. That could be a $2.5 billion drop in revenue in 2012.

Though on the bright side Medicaid rebates will go down...

Okay, we don't seriously expect Lilly to celebrate the loss of Zyprexa. But it does provide a useful reminder of what the company has to look forward to after 2011 as health care reform picks up steam. We'll explore that theme in Part Two.

image by flickr user ansik used under a creative commons license

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