Health care companies are lining up to sample a new growth hormone. This spring, dozens of health care players will participate in a trial designed to test a new Medicare drug benefit that, if successful, could generate substantial new business for the industry. So far, 28 companies -- including the three dominant pharmacy benefit managers, Medco Health ( MHS), Caremark ( CMX) and Express Scripts ( ESRX) -- have been authorized to begin offering discount drug cards this June. The cards themselves may do little to boost near-term industry profits, but they will allow participating companies to forge important relationships with Medicare customers before the full-blown drug benefit takes effect in 2006. "We see the card program mostly as a test of whether the bigger drug benefit will be successful," Prudential analyst Diane Duston explained in a research note last week. "Sponsors of the new drug card are investing in a temporary program, which would hardly seem worthwhile unless it leads to business in the larger drug benefit." Participating companies will offer the cards -- providing discounts of 10% to 25% on prescriptions drugs -- for a $30 fee that, Duston believes, won't even cover administrative costs associated with the program. But the companies will still enjoy some benefits as they wait for big returns down the road. For starters, Duston noted, they can rely on the federal government to market their cards to millions of Medicare beneficiaries. The government hopes to shift seven million people -- or nearly 18% of the total Medicare population -- onto discount drug cards before the full benefit kicks in.
startling report warned last week that the new prescription drug benefit could shave two years from the life of a Medicare program that, without changes, could wind up bankrupt by 2019. But industry players, who have pushed the Medicare reforms, remain optimistic. The PBMs -- eyeing a new multibillion-dollar market -- are especially excited.
Indeed, the nation's largest PBM officially welcomed the opportunity to serve the huge Medicare crowd. Medco pointed to its new Medicare-approved discount drug card as "an important first step" in bringing affordable prescription drugs to senior citizens. "We intend to leverage our size and scale for the Medicare population, just as we do for our other clients today, to deliver a total solution -- best price and value, and a clinical excellence program designed for the unique issues confronted by seniors," Medco CEO David Snow announced last week. (Medco is the pharmacy benefit manager for TheStreet.com Inc. ( TSCM), publisher of this Web site.) Medco could use some new opportunities right now. Lately, it has been losing existing business to major competitors. In recent months, the company has watched some of its biggest customers -- most notably the federal government -- choose Caremark or AdvancePCS, two big benefit managers that recently merged, as their PBM instead. Medco lost the big contracts after federal authorities sued the company for allegedly defrauding government customers by failing to properly fill their prescriptions and charging them for medicine they never received. But Caremark, the surviving entity of last week's merger, faces similar allegations as well. Moreover, it also has been accused of reselling returned drugs and then booking the profits twice. For its part, Caremark has consistently denied any wrongdoing. But the company recently went a step further, one Chicago attorney says, by filing a lawsuit against its accuser. Mike Leonard, who is representing two Caremark pharmacists in a whisteblower lawsuit, said Caremark is now accusing one of his clients of improperly taking documents from the company. "It appears to be a desperate act by a company that knows that there are documents out there that evidence its alleged fraud," Leonard stated. "Also ... in my opinion, it appears that Caremark is trying to send a message to its other employees not to cooperate in this suit and making it clear, at least by way of implication, that if they do, they too might be sued by Caremark."
Leonard says that Caremark is particularly concerned about dated envelopes that represent "the most direct evidence" that the company falsified turnaround times in order to collect bonuses. He said the company was aware of his clients' evidence for months but filed suit in recent weeks only after a high-ranking Caremark manager offered damaging testimony that bolstered his client's claims. Leonard has estimated potential damages in the case at $100 million.
Following its recent merger, Caremark has managed to further dominate an industry already concentrated in the hands of a very few. Critics have long fretted over the lack of competition -- and the potential for abuses -- in a sector where three PBMs, including the enlarged Caremark, control more than 70% of all mail-order prescriptions. Caremark's buy leaves No. 3 player Express Scripts trailing far behind. "We believe this market has been transformed from a four-player oligopoly to a two-player duopoly dominated by Medco and Caremark," Piper Jaffray analyst Daren Marhula wrote last week. Marhula, for one, is excited. He sees great opportunities for big PBMs -- even without new Medicare offerings. And he especially likes Caremark, whose shares are trading within a dollar of an eight-year high set earlier this month. On Friday, the stock added 11 cents to $33.20. "Caremark continues to be our favorite stock pick," he wrote. "We believe it will be the stock with the 'sizzle' over the next year."