A Pharma Proposal Homer Simpson Could Love

Drug companies have pledged to hand out $80 billion worth of doughnut holes over the next decade to low- and middle-income seniors, complete with a side of good PR.

No, it's not some weird ploy to increase the rate of diabetes. These doughnut holes, in the form of rebates on branded drugs, will fill the hole left in Medicare Part D prescription coverage. Under the current plan, seniors on that plan pay a portion of the drug prescription costs up to a point, then pay all of the coverage for a while -- the hole in the doughnut -- until catastrophic drug benefits kicks in.

The rebates, which will reach 50% in some cases, will cut into margins, but the companies can afford it. They won't be losing money on the seniors they have to give rebates to, because the gross margins on drugs are so high.

Company

Gross Margin (TTM)

Pfizer (NYSE: PFE  )

85.9%

Merck (NYSE: MRK  )

76%

Amgen (Nasdaq: AMGN  )

84.9%

Biogen Idec (Nasdaq: BIIB  )

90.5%

GlaxoSmithKline (NYSE: GSK  )

76.8%

Source: Capital IQ, a division of Standard & Poor's. TTM = trailing 12 months.

In exchange for the rebate, the industry gets some goodwill, not only with seniors, but with the government, which has been pressuring the industry to lower the cost of drugs.

It's also not a complete loss for drug companies. Because many seniors cut back their drug use as they hit the hole in coverage and don't make it to the catastrophic coverage stage, drug companies may be able to make up some of the costs on the other side when coverage kicks back in.

Overall, this looks like a good move by the industry. Drug companies were going to have to concede something during health-care reform, and this looks like it won't hurt much. Let's just hope the government doesn't come back with a request for a baker's dozen of concessions.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any company mentioned in this article. Pfizer is an Inside Value choice. The Fool's disclosure policy (and editors) won't be able to stop thinking about doughnuts for the rest of the day. Thanks a lot, Brian.


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