Wednesday, April 7, 2010 as of 11:14 AM ET
Published October 28, 2010
| FOXBusiness
Research & development programs are already being drastically scaled back. There are dwindling incentives to create new drugs and vaccines. And the full impact to the drug and medical devices sectors from the new health-care law is yet to be fully scoped out.
FOX Business is taking a microscope to how health reform will affect these companies and inevitably your wallets. Drug companies like Pfizer, Bristol Myers Squibb and Eli Lilly are already disclosing profit hits from a little-understood and little-known tax on drug sales hidden in the law. Medical device makers, too, are curtailing R&D and possibly new jobs.
Moreover, we're finding the government gets to define what is a sale of a drug or a medical device that is to be taxed under the new health reform bill.
First up: The drug companies didn't get off scotfree, despite news reports that the Administration made a cloakroom deal with them to deliver up to $80 billion in savings to help pay the cost of insuring 32 million more Americans. In return, it was widely reported the government gave the drug industry the costly promise that Medicare won't negotiate prescription drug prices, and that the US would not import cheaper drugs from Canada. Such ephemeral cost-saving promises have been made in attempts to enact health reform since the "?70s.
Promises about as easy to catch as a gnat in a hurricane.
But it wasn't such a clean getaway for the drug companies.
The health reform will hit the drug industry with an estimated $2.5 billion in new taxes in 2011, estimated to rise to $4.1 billion in 2018 and thereafter.
There are also new taxes on medical device manufacturers in the new bill as well, a new excise tax in 2013 of 2.3% on sales -- not profits, sales -- of any and all "taxable medical devices" as defined by the government.
The tab here? About $20 billion over the next 10 years.
Again, who gets to define these new taxes and fees? The government. How long do you think the drug makers and medical device makers will sit tight before passing along those new costs to taxpayers?
Drug Companies Disclose Profit Hits from Health Reform
Several big drug companies have already told FOX Business that the health reform bill's new regulations and fees are already starting to hit their earnings. Bristol Myers Squibb (BMY) in its third quarter earnings report released earlier this week said it took a negative earnings per share impact of two cents a share because of health reform. That equated to $77 million in lost sales for the quarter. For all of 2010, Bristol said it lost $300 million in sales because of healthcare. That equates to a dime a share. And for next year, Bristol predicts a negative impact of $600 million to $650 million, which is an EPS haircut of about a quarter.
Johnson & Johnson (JNJ) says healthcare overhaul will cost it between $400 million and $500 million in sales this year. Eli Lilly (LLY) says the healthcare overhaul will cost it $700 million in revenue next year, 3% of its global sales. Pfizer (PFE) expects revenues to be negatively impacted by $300 million this year and by $900 million next year.
Additionally, medical device makers -- an industry that employs 420,000 workers and shipped $136 billion worth of product last year -- will be faced with a 2.3% tax on devices starting in 2013. Again, this tax is expected to generate $20 billion for the government.
How Exactly is Health Reform Affecting Drug Makers?
Along with the medical device tax, health reform also has a new tax on branded prescription drugs sold to government programs like Medicare, the Department of Defense and Veteran Affairs that is a tangled pile of fishing tackle to figure out. The fee computation alone is nothing short of a calculator-busting convolution.
The tax is estimated to cost the drug industry $2.5 billion in 2011, gradually increasing to $4.1 billion in 2018, and then is $2.8 billion after 2019. It exempts the first $5 million in sales from calculation and uses a sliding scale for percentage of sales taken into account.
But the reform bill directs the Secretary of the Treasury to determine each company's fee annually, based on the market share and sales figures for the drugs the manufacturers sell to government programs.
It goes like this. The fee is calculated by determining first "the percentage of sales taken into account."
If the aggregate sales of a company's "branded prescription drugs" are less than $5 million, the percent is 0%.
If the sales fall between $5 million and $125 million, then it is 10%. If between $125 million and $225 million, then it is 75%. If more than $400 million, then it is 100%. The following example may help, courtesy of the FDA Law Update blog:
Say the amount of sales reported to Treasury for a company's "branded prescription drugs" sold to government programs is $100 million.
The percent taken into account is then 10% of that or $10 million.
Say the total of all "sales taken into account" for all manufacturers is $25 billion. The company's percent is 10 million divided by 2.5 billion or 0.004%. If the sales remain the same, for 2011 the company pays 0.004% of the "applicable amount" for 2011-2.5 billion, or $10 million. If the same were true for 2012, they will pay 0.004 percent of 2.8 billion or $11,200,000.
What About New Medicare Discounts Drug Makers Must Now Deliver?
Drug companies may pass those discounts along to customers in other ways, too. Medicare Part D, a federal program that subsidizes the costs of prescription drugs for Medicare beneficiaries in the United States. In 2010, the standard Medicare Part D benefit requires payment of a $310 deductible, then 25% coinsurance drug costs up to an initial coverage limit of $2,830.
Once this initial coverage limit is reached, the senior citizen must then pay the full cost of his/her prescription drugs up until the total out-of-pocket expenses reach $4,550 (excluding premiums). This coverage gap between the initial coverage limit and the catastrophic coverage limit is referred to as the "Donut Hole".
Once the beneficiary reaches catastrophic coverage, he or she then pays the greater of 5% coinsurance, or $2.50 for generic drugs and $6.30 for brand-named drugs.
So this is what health reform did....and this is what has the big drug companies upset. According to a press release dated September 23rd entitled "Medicare beneficiaries in donut hole will see 50% discount on brand name drugs in 2011," Vice President Joe Biden, the U.S. Department of Health and Human Services and the Centers for Medicare & Medicaid Services (CMS) announced that "the nation's pharmaceutical manufacturers will provide 50% discounts on the cost of covered brand-name prescription drugs for beneficiaries in the Medicare Part D coverage gap, or donut hole, starting in 2011."
Again, how long before drug makers pass along the costs of those "discounts" in the form of higher prices for drugs not in this Medicare program?
Who Calculates the Drug Makers' Sales Under Reform?
Covington & Burling LLP, an international law firm based in New York City, says new fees and taxes on drug sales to government programs like Medicare and to Veterans Affairs can be found in section 9008 of health reform, and sections 1404 and 1405 of the Reconciliation Amendments. Who calculates the sales amount though? Not the drug companies. The government does.
Covington & Burling notes that the reform law says that "the Secretary of the Treasury will determine each drug companies' branded prescription drug sales on the basis of reports submitted by the Secretary of Health and Human Services, the Secretary of Veterans Affairs, and the Secretary of Defense, and will calculate the fee payable by each covered entity."
Given the convoluted language, you can see why the accounting and consulting industry's growth rates will explode due to health reform.
Has Your Head Exploded Yet?
How must a drug maker calculate the fee? It's assessed based on market share"”not much more detail here, though. Covington & Burling says that first, a drug maker must use the reform law's new definition of market share, defined by the new law as a drug maker's "aggregate sales of branded prescription drugs during the preceding calendar year as a percentage of the aggregate branded prescription drug sales of all covered entities (meaning, other drug companies) during that year."
Has Your Head Exploded Yet? Mine Has
The health reform bill slaps an excise tax equal to 2.3% of the sale price on the sale of any "taxable medical device" by the manufacturer, producer, or importer. The government decides what is a "taxable medical device" under section 201(h) of the Federal Food, Drug, and Cosmetic Act: "an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component, part, or accessory, which is"¦intended for use in the diagnosis of disease or other conditions..or [is] intended to affect the structure or any function of the body."
Course there are exemptions to the new reform law as determined by the government.
"There is an exemption for eyeglasses, contact lenses, hearing aids, and any other medical device determined by Treasury to be of a type which is generally purchased by the general public at retail for individual use," Covington & Burling says.
Whatever that is.
Medical Device Makers React
Zoll Medical, a big medical device and software company in Chelmsford, Massachusetts that makes heart defibrillators and heart pumps, already tells FOX Business that health reform will be a major drain on his company and will hurt hiring as well as research and development. Zoll Medical does $450 million a year in sales, has 1,900 workers and spends 10% of its revenue "“ or $45 million "“ on R&D every year.
Zoll CEO Richard Parker says he is very concerned about the excise tax hitting sales, not profits. This is expected to generate $20 billion for the government over 10 years, but Parker expects it to dramatically hurt his company.
And so, he says he will be forced to cut back on R&D spending; and, in his five-year plan for the company, he expects to no longer hire more workers, and says he may even shift jobs and manufacturing overseas to reduce costs.
Similarly, Invacare, the world's leading manufacturer of wheelchairs and disability scooters, based in Elyria, Ohio, has already disclosed to the Securities and Exchange Commission that it expects to pay between $12 million and $14 million a year in excise taxes on the sales of medical devices.
To start saving money, Invacare has "already taken steps to suspend matching contributions under its 401(k) retirement plan, suspend merit pay increases for management employees and freeze new hiring," according to its SEC filing.
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