Dec. 24 (Bloomberg) -- U.S. states from California to Maine, already facing a surge in the cost of providing health care to the poor, may be big losers again with the $395 billion overhaul of the federal Medicare program for the elderly.

While companies such as Pfizer Inc. and Merck & Co. gain because the law will help seniors buy prescription drugs, states must cede control of $16 billion in their drug spending for the elderly poor by 2006, when Medicare starts managing those costs.

That will weaken the bargaining clout of Florida, Michigan and other states that have negotiated wholesale-price discounts of 40 percent or more from drugmakers and must still pay most of the elderly poor's drug costs even after 2006.

``Alarm bells are starting to go off,'' Michigan Governor Jennifer Granholm said in an interview in her office in Lansing, the capital. ``How much money is the federal government going to push back onto the states?''

Congress's approval of the Medicare bill last month followed a lobbying campaign by health-care companies, led by Merck, Eli Lilly & Co. and Pfizer. They spent a record $139.1 million in the first half of the year alone backing the measure, which expands prescription-drug coverage for the 41 million seniors on Medicare.

At stake for the companies in the bill, signed by President George W. Bush on Dec. 8, is an increase in drug sales that Goldman Sachs Group Inc. estimates may be as much as $13 billion a year as more people are able to afford prescription medicine.

Suing the States

Taking negotiating power from the states may benefit pharmaceutical companies, which have objected so strongly to states' efforts to force discounts that they have sued Maine, Vermont, Florida and Michigan. Florida saved more than $500 million between fiscal 2001 and 2003 through drug discounts.

The Standard & Poor's 500 Pharmaceuticals Index has climbed 7.4 percent since Nov. 11, the day before Senator John Breaux said congressional negotiators reached a tentative accord on the bill's most contentious issues, setting the stage for a compromise.

The National Conference of State Legislatures said it was ``totally disappointed'' with the Medicare bill, though drugmakers won the support of the Republican Governors Association. The association has gotten more than $550,000 from the companies this year, including $110,000 from Pfizer in October.

``As long as the decision-making power is away from the states when the program starts in 2006, that's got to be considered a win'' for the pharmaceutical industry, said Alec Phillips, a policy analyst at Goldman Sachs Group Inc.

`Dual Eligibles'

At issue are 6 million ``dual eligibles'' -- elderly people who qualify for both Medicare and Medicaid, a state-run health- insurance plan for poor people of all ages that already provides a drug benefit. About half the $32 billion that Medicaid spends on drugs goes to elderly recipients.

States' Medicaid bills have soared, with spending on medicine growing about 10 percent a year since 1998, according to U.S. government figures. The states wanted the federal government to take over the total cost of the drug benefit. Instead, they will have to pay 90 percent of the tab for the 6 million seniors, while losing the power to bargain.

Private insurers that the federal government will hire to bargain on prices typically get discounts of only about 20 percent when buying drugs for employers and other private purchasers, according to research by Stephen Schondelmeyer, a pharmaceutical economics professor at the University of Minnesota.

Aetna Inc., Cigna Corp. and UnitedHealth Group Inc. are among the insurers that have expressed interest in managing the drug plan for Medicare.

Budget Deficits

Ten of the 50 states face budget deficits, including California, the most populous, and Medicaid is the second-largest spending item after education. A survey of budget officers found that 32 states expect a shortfall in this year's Medicaid budgets.

State deficits this fiscal year total $2.8 billion, according to the National Conference of State Legislatures.

Against that backdrop, states say they're concerned that drug prices may rise. Michigan and Vermont officials say they've saved 11 percent on Medicaid drug spending by pooling their purchasing power and demanding extra discounts.

Proponents of the Medicare law, such as House Ways and Means Committee Chairman Bill Thomas, say it will control drug prices. The legislation gives insurers the power to negotiate prices lower than those that Medicaid pays, they say.

The legislation ``will allow competitive forces in the private market to generate the best savings for seniors,'' said Molly Millerwise, a spokeswoman for Thomas.

No Incentive

``The prescription drug plans have a financial stake in aggressively negotiating down drug prices,'' Millerwise said in an e-mail. ``A government bureaucracy has no such incentive.''

The Congressional Budget Office estimated that a similar provision in a Medicare bill that was proposed last year would have saved $18 billion over 10 years on the cost of drugs, more than have government-run plans.

Goldman Sachs's Phillips disagrees, saying he doesn't expect Medicare will pay less for medicine than Medicaid does.

John Colmers, who studies health policy for Milbank Memorial Fund, a foundation, said private insurers ``may not be as effective purchasers as states have been.'' The reason: They know that ultimately government will pick up the bill, he said.

States have driven such hard bargains in negotiating drug prices that companies including Pfizer sometimes try to persuade them to accept cost-saving agreements that avoid discounts.

Pfizer set up a program in Florida in 2001 to ensure that patients with chronic diseases such as diabetes took medication and saw doctors regularly to avoid costly hospitalizations.

`A Very Good Job'

The company said in September it's renewing that agreement, promising Florida $45 million in savings in the next two years.

``The states have done a very good job at negotiating supplemental discounts, and they're proud of that,'' said Vernon Smith, a former Michigan Medicaid director who is a principal at Michigan-based consulting firm Health Management Associates.

Drugmakers have tried other tactics. The Pharmaceutical Research and Manufacturers of America, a trade group, has sued states over attempts to control drug spending.

Drug industry representatives say the concern is premature. Jeff Trewhitt, a spokesman for the trade association, said it's too early to tell how the Medicare law will affect states.

Ian Spatz, executive director of Merck's Washington office, said states will still control the rest of Medicaid's drug purchasing, so pharmaceutical companies will have to be careful in dealing with them.

`Clawing Back'

``For the portion of state expenditures that they still control, states will have that same power'' to negotiate discounts, Spatz said.

Drugmakers say the bill isn't a windfall for them. The new business from the government will probably push prices down, Pfizer Chief Executive Hank McKinnell said.

``On balance, it is probably a neutral,'' McKinnell said in a televised interview with Bloomberg last month.

State costs for drug purchases for the 6 million elderly on Medicaid will decline to 75 percent by 2015, a provision of the law dubbed ``the clawback'' by lobbyists. Milbank's Colmers says that's not enough.

``Medicare's cynical but appropriately named `clawback' provision requires states and taxpayers to pay in perpetuity most of what is spent on dual eligibles, yet they must cede control of that to private drug plans,'' he said.

Forty-two states may address pharmaceutical cost-control measures in their Medicaid programs next year, and 32 will consider creating or expanding prescription-drug bulk-purchasing pools, the National Conference of State Legislatures says.

Congressional Democrats are considering legislation that would return bargaining power to states, said Representative Sherrod Brown of Ohio, senior Democrat on the House Energy and Commerce Committee's health panel.

``The states are getting hurt by this,'' Brown said. ``The drug companies aren't.''

Last Updated: December 24, 2003 00:12 EST