This $581 Doughnut Hole Costs Drugmakers

This ain't your Homer-Simpson-style doughnut hole.

The Medicare doughnut hole is something seniors fall into as they exit the individual Medicare Part D drug coverage before they're covered by catastrophic coverage. As they go through the middle of the doughnut of coverage, they're on their own to cover the cost of prescriptions.

According to the Associated Press, that gap in coverage has gotten a little smaller. Instead of paying an average of $1,504 this year, seniors paid only $901.

The costs didn't magically disappear, though. A paltry $22 was saved because Medicare picked up more of the cost of generics, but a bulk of the savings -- $581 per person -- came from discounts that drug companies were forced to give through the health-reform bill.

Drugs that are used by the elderly -- cholesterol drugs such as Merck's (NYS: MRK) Vytorin and Pfizer's (NYS: PFE) Lipitor, for example -- will be hit disproportionately. Investors in companies with drugs in development for diseases that treat the elderly -- Elan (NYS: ELN) and Targacept (NAS: TRGT) , for example, both have or Alzheimer's disease drugs in development -- will have to factor in the discounts.

Margins are high enough on brand-name drugs that I doubt companies are losing money offering 50% discounts, but it's still money straight out of the bottom line.

Earning some good press
Drugmakers are made out to look like the bad guy in the health-care system in part because the price of drugs is more visible than the cost of other health-care products or services. A little good press by offering a discount -- even if it was required by law -- can't be all that bad.

And getting patients through the doughnut hole has fringe benefits. Some seniors may just stop taking medication after their initial benefit runs out. By offering discounts, the seniors might stay on medications and get to the point where catastrophic coverage kicks in.

The real payoff
The doughnut-hole discount wasn't so much forced upon drugmakers as negotiated. Drugmakers took an early, active role in the lawmaking process that will hopefully pay off in the long run. Hopefully.

While conceding discounts for Medicare and Medicaid, the health-reform law works in drugmakers' favor by increasing the number of people covered by insurance. And insured people are more likely to get and fill prescriptions.

The provision that requires insurance to cover children on their parents' insurance has already kicked in. According to a Gallup Poll, the uninsured rate for 18- to 25-year-olds has dropped to 24.2% from 28% in mid-2010.

The real increase will come when the insurance mandate kicks in. At that point, most Americans will be covered or face fines. Most of those additional lives are likely to be healthy people that didn't feel the need for coverage. But at the same time, the law requires health-insurers like UnitedHealth Group (NYS: UNH) , Aetna (NYS: AET) , and Humana (NYS: HUM) to cover all individuals with pre-existing conditions. A majority of those people, by definition, need treatment and should increase the use of drugs.

That is, if the Supreme Court doesn't rule against the law. The court is scheduled to hear arguments in February or March, with a ruling on the constitutionality of the insurance mandate by June.

Ruling the law unconstitutional would be disastrous for health insurers that are counting on the healthy individuals to balance out the sicker people with pre-existing conditions. Rather than let them go out of business, it seems likely that if the courts remove the mandate, Congress would repeal the requirement to cover pre-existing conditions. While it's possible that the Medicare doughnut-hole discount might be repealed as well, it's seen as less tied together with the insurance mandate, and I wouldn't be surprised to see it remain.

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At the time thisarticle was published Fool contributorBrian Orelliholds no position in any company mentioned. Check out hisholdings and a short bio. The Motley Fool owns shares of UnitedHealth Group.Motley Fool newsletter serviceshave recommended buying shares of Elan, UnitedHealth Group, and Pfizer and creating a diagonal call position in UnitedHealth Group. Try any of our Foolish newsletter servicesfree for 30 days. We Fools don't all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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