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Parker Conrad

Medicare is a government program that covers most health care costs for people 65 and older, as well as individuals undergoing dialysis treatment for kidney failure. Medicare covers over forty million Americans – around 13% of the U.S. population.

Medicare is so large that its decisions on what to pay for and how much to pay for it dramatically impact the business of healthcare in the United States. When Medicare increases the amount it reimburses doctors for a particular treatment, it can change medical practice, as doctors and hospitals favor more profitable treatments. As these practice patterns change, some companies stand to profit handsomely and others lose out.

As a result, Medicare's decisions around what to pay for and at what price are subject to intense political scrutiny. The pharmaceutical companies with the most at stake when Medicare reimbursement changes also tend to have the largest government lobbying teams.

Pressure to Curb Costs

In recent years, the Center for Medicare and Medicaid Services (CMS) -- the federal bureaucracy that manages medicare -- has come under increasing pressure to cut costs. Medicare costs the Federal Government nearly $300 billion a year, around 12% of the federal budget, and costs are growing faster than other Federal spending. Democrats have made a reduction in Medicare costs via cuts to reimbursement a key part of their platform, and Democratic victory in the 2008 elections could presage additional cuts to medicare reimbursement, negatively impacting companies who rely upon medicare reimbursement for their revenues.

How Medicare Spending Breaks Down

Roughly, medicare's spending is divided into three main areas, and each area has been a target for cost-cutting at one point or another:

• Part A: Medicare "Part A" covers patients for hospital stays. It typically pays a flat rate based on a patient's diagnosis. As a result, hospitals treating medicare patients who are checked in to the hospital have an incentive to minimize costs and discharge the patient as rapidly as possible. Medicare pays for some procedures -- such as the implantation of drug-eluting stents -- at rates much higher than what it costs a hospital to provide them, which creates an incentive for hospitals to offer these procedures to their patients. Hospitals claim that for other procedures, the cost of caring for a patient is greater than what medicare reimburses.
• Part B: Medicare "Part B" pays for medical procedures that do not involve an overnight hospital stay. Importantly, part B also pays for drugs that are injected at a physicians office as part of a "medical procedure". This includes many costly drugs such as chemotherapy for cancer patients and the latest and most expensive biotechnology drugs. Currently, injectable drugs are reimbursed on a "cost plus" system -- meaning that medicare pays doctors more than it costs the doctors to acquire the drugs in the first place, making it a frequent target of cost-cutting measures.
• Part D: Medicare "Part D" is a prescription drug plan, launched in 2006, that pays for seniors' "pill" drugs. The government pays private insurance companies a per-patient fee to offer Medicare beneficiaries prescription drug coverage. Recent news coverage has highlighted the fact that Medicare pays insurance companies more per patient than it costs to insure a patient, making it another frequent target of cost-cutting measures.

Which Companies are Impacted by Cuts to Medicare Spending?

• Hospitals and hospitals chains such as Tenet Healthcare and Triad Hospitals are hurt when Medicare reimbursement goes down, as it means the government pays them less money for treating a Medicare patient. Additionally, private insurers tend to follow Medicare's lead on payment decisions, so Medicare's decision to lower its reimbursement rate often precipitates a similar decision by private health insurers.

• Dialysis chains that provide dialysis for patients with End Stage Renal Disease, particularly Davita and Fresenius, have a lot to lose when Medicare Part B reimbursement goes down. Only a fraction of other healthcare providers' patients will be over 65 and covered by Medicare. However, because virtually all dialysis patients are covered by Medicare, the impact of changes in medicare reimbursement is magnified for dialysis companies. Reductions in medicare payment could impact not only these centers' profits on dialysis treatment, but also their profits on specialized biotechnology drugs, particularly Epogen, which by some accounts represents 25% of their net income.

• Drug companies that make drugs for patients with kidney failure, such as Amgen and Genzyme, are particularly exposed to cuts in Medicare reimbursement. Almost all patients taking these drugs will be eligible for Medicare. When medicare reduces the amount they pay for these drugs, in can reduce the incentive that doctors and dialysis chains have to use them, leading to drops in sales.

• Manufacturers of medical equipment, such as Advanced Medical Optics, benefit when the procedures they manufacture devices for, such as cataract surgery and laser vision correction, are covered by Medicare.

• Manufacturers of medical devices, such as Medtronic (MDT), Stryker (SYK), C.R. Bard (BCR), and St. Jude Medical (STJ) benefit when medical devices such as pacemakers are covered by Medicare.

• Pharmaceutical companies that produce generic drugs may benefit from a cut in Medicare spending, generics which are generally cheaper become the more affordable choice for many patients. Barr Pharmaceuticals (BRL) one of the leading generics companies falls into this category.

When Medicare decides to increase the amount it pays for a particular drug or treatment, companies that provide that treatment can stand to profit handsomely. The amount that Medicare reimburses doctors, hospitals, and third-party health insurance companies can impact these companies' profitability. It can also affect the incentive that health care providers have to offer certain treatments, biasing providers towards procedures that have higher Medicare payments.