Lilly's $1 Billion Investment in Health Care Reform (Part 2): Remember the Upside

In part one we did our best to explain the relatively huge cost Lilly put on the impact of health care reform in 2010 and 2011, pointing out that the company is in effect a victim of its own success in defending Zyprexa from pricing pressure in the past.

But we also think Lilly's estimates about the cost of reform don't tell the whole story

Take the company’s forecast for 2011, with revenue guidance cut by $600 million to $700 million. There, in addition to the ongoing impact of the Medicaid rebates (so about $400 million or so), Lilly sees another $200-$300 million impact from the new market share fee in the US and from the start of the donut-hole discount program.

Now there is no escaping the fee, though as Lilly noted the exact amount is still tough to calculate. However, we figure Lilly’s share will be in the $100-$130 million range. That’s a real hit.

The donut hole discount, however, is another matter. There is no doubt that the 50% discount will show up in Lilly’s reports as a deduction from revenue (along with Medicaid rebates, chargebacks, etc.). It is just that the discount is also likely to induce wider use of brands in the lucrative Part D population.

But Lilly is not baking in any benefit from behavioral change in response to the donut hole discount. The company did say it is counting the potential benefit for products like Forteo where there is a relatively high percentage of patients who stop therapy in the donut hole, but noted that is a small amount.

It is very hard to predict whether prescribers and patients will start to use more brands knowing that the cost of the donut hole will be lower. Lilly's initial read is that a 50% discount won't be enough. Maybe they are right--but they may be wrong too.

The Congressional Budget Office certainly saw things differently: CBO estimated that the net impact of the donut hole discount in 2011 would be to increase federal spending on pharmaceuticals by something on the order of $1.0 billion. (The exact amounts are difficult to break out of the CBO score).

Could there be another Part D surprise upside in 2011? We will see.

And Lilly definitely didn't even attempt to quantify the intangible benefits of the law. For instance, the new 12 year data exclusivity granted to biologic products. That immediately makes Lilly’s pipeline more valuable, at a time when the company notes that “biotech molecules represent half of our late-stage Phase II and Phase III assets and over a third of our overall clinical portfolio.”

That’s not top-line revenue or bottom line earnings, but it is real.

And then there is that backloaded stuff in the bill. You know, the part where the federal government kicks in a share of the donut hole, basically paying back the market share fee in the form of coverage for Medicare Part D. And the 32 million new lives expected to gain insurance.

Thanks to reform, the federal government will be spending a lot more subsidizing health care in the years to come. ($934 billion more, according to CBO.)

Some of that money will pay for pharmaceuticals. Ten percent, say? That is a lot of dough. So Lilly will spend $1 billion over the next two years in hopes of big payoff in the middle of the decade.

Say, isn't that exactly what Lilly does? $1 billion is just one quarter's worth of R&D for Lilly, and we'd wager this billion is much more certain to deliver an attractive RoI than the average incremental billion spent by Lilly on R&D the past decade.

This is an industry used to making large investments over several years in hopes of an uncertain payoff. Health care reform requires similar patience—but with a more certain payoff.

flickr image by amy_b used under a creative commons license