It's hard to sell a drug if your main customer isn't willing to pay for it.

That's the situation Eli Lilly (NYSE:LLY) finds itself in after the Centers for Medicare and Medicaid Services, or CMS, issued a draft decision last month proposing that the agency not cover the company's Alzheimer's diagnostic Amyvid outside of clinical trials.

That's a big blow for Eli Lilly, which paid $300 million up front for Amyvid's developer Avid and $500 million more in milestones. Fortunately, some of those milestones were tied to sales, so Eli Lilly likely won't be paying them any time soon.

Amyvid is used to identify amyloid plaques seen in patients with Alzheimer's disease, and CMS doesn't seem to have a problem with the diagnostic doing what it's supposed to.

"Evidentiary gaps"
While it's clear that Amyvid identifies amyloid plaques, it's less clear whether amyloid plaques are the cause of Alzheimer's disease or just a by-product. CMS wants more data to show how identifying the amyloid plaques helps the patient.

The fact that there are limited options for Alzheimer's patients and that they don't work all that well probably doesn't help the situation. Why pay for a diagnostic to identify patients who should be treated with drugs that don't work? (Technically, Amyvid rules out patients who don't have amyloid plaques rather than diagnosing Alzheimer's, but the corollary would also seem to be true.)

Interestingly, CMS is willing to pay for diagnosis with Amyvid when used to determine who should be enrolled in a clinical trial. CMS seems to be saying that the usefulness of Amyvid is inevitably tied to a drugmaker finding a useful drug for the disease. And identifying and enrolling the correct patients can help cut down the noise, making it easier to identify effective drugs.

That kind of research has already started. Brigham and Women's Hospital is using Amyvid to determine whether patients should enter a prevention trial testing Lilly's solanezumab. Merck (NYSE:MRK) is using General Electric's (NYSE:GE) competing amyloid-identifying diagnostic in its phase 2/3 trial of MK-8931.

Dollars over doctors?
In the way the system has always worked, the FDA approved drugs, doctors prescribe the drug, and CMS pays for them. There might have been a little pushback from CMS to keep doctors from prescribing drugs off label, but CMS deferred to the FDA even if it wasn't technically required to.

When Dendreon (NASDAQ:DNDN) underwent its CMS review of Provenge, I told readers not to worry. FDA approval was sufficient to gain reimbursement. It was.

Now I'm worried.

With the push to lower costs, it's clear CMS isn't willing to pay for every FDA approved drug. That's always been a possibility. Now it's a reality.

When valuing companies with drugs that primarily treat the elderly, investors will need to evaluate the possibility that CMS may not pay for the drug. With just one drug having been denied coverage, figuring out where the line is won't be easy.

Fool contributor Brian Orelli has no position in any stocks mentioned. The Motley Fool owns shares of Dendreon and General Electric Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.