'There appears to be no rational policy justification for providing this immense hidden subsidy to the drug industry.... It appears that the only party benefiting in this arrangement are the drug companies that give millions to the Republican leaders who drafted the legislation,' said Rep. Henry Waxman, D-Calif.

The hefty windfall raises new concerns that the Bush administration won't fully realize its promises of lower drug prices in the troubled new program.

The boost in profits comes from a shift in the drug coverage of 6.4 million poor and elderly people from Medicaid to the new Medicare drug benefit. Unlike Medicaid, which requires drug companies to charge their lowest or "best price" for medications, the Medicare program relies on competition among private drug plans to keep prices low. By eliminating the need to discount drugs for the government, the industry can now pocket the savings.

"The net effect over 10 years is probably closer to $40 billion in extra profit," said Stephen Schondelmeyer, a pharmaceutical economics professor at the University of Minnesota.

At the Expense of Taxpayers?

A little-known study by the Prudential Equity Group from June 2005 estimated that the makers of three anti-psychotic medications stand to benefit most from the change, taking in roughly $1.1 billion in new profits on products used by the 6.4 million who are Medicare's most poor and frail patients.

Experts say drug prices in the Medicare program will be higher this year than prices under Medicaid because the private Medicare drug plans won't likely match the price discounts achieved by Medicaid, the joint state and federal health program for the poor.

But the new profit estimates and the higher drug price projections have rekindled accusations that the Medicare drug benefit enriches drug companies at the expense of US taxpayers.

Medicare administrator Mark McClellan questioned Prudential's findings. In testimony before the Senate Special Committee on Aging on Thursday, he said Medicare plans are covering people at a cost average of 15 percent less than expected, which has helped push the average plan premium down to $25 from an original estimate of $37.

As a result, the cost of the drug plan likely will be $30.5 billion in 2006, down from an earlier estimate of $38.1 billion, McClellan testified. And the program's 10-year cost estimate has likewise dipped from $926 billion to $797 billion.

"The drug plans are negotiating aggressive discounts and rebates that are being passed along to beneficiaries and taxpayers," McClellan said.

Big Winners: Seroquel, Lamictal, Zyprexa

According to Prudential, the medications that will gain the most and the profits they're likely to reap are Seroquel by AstraZeneca ($521 million); Lamictal by GlaxoSmithKline ($298 million) and Zyprexa by Eli Lilly ($285 million).

Those figures reflect Prudential's estimates that Medicare drug plans will negotiate discounts amounting to only 5 percent of what the drug companies paid in rebates to Medicaid on those products.

An AstraZeneca spokesperson questioned the study's methodology, saying the profit estimate for Seroquel, a schizophrenia medication, was too high. AstraZeneca gave no alternate figures. A GlaxoSmithKline spokesperson wouldn't discuss projected earnings for Lamictal, a treatment for bipolar disorder. A spokesperson for Lilly said the company expected only a "modest short-term benefit to sales" for Zyprexa under the Medicare program, but wouldn't give specifics.

Zyprexa, also a schizophrenia treatment, is Lilly's top-selling product, with US sales of $2.04 billion in 2005. Lilly's earnings per share could rise by 6 percent in 2006 just by escaping the rebates, the Prudential study estimates.

With US sales of $2.76 billion in 2005, Seroquel's increased Medicare profit could boost AstraZeneca's earnings per share by 8 percent, the report found.

Company policy prohibits Prudential analysts from discussing reports with non-clients, said company spokesman Jim Gorman.

Drafted by Drug Industry Lobbyists?

Tony Butler, managing director and pharmaceutical analyst at Lehman Bros., an investment bank in New York, agreed with the report that Medicare would probably have higher drug prices than Medicaid. Butler estimated the sales windfall for drug companies under Medicare to be between $1.8 billion and $2 billion.

He said profits would likely increase in coming years as more businesses cut retirees' drug benefits and steer their former employees into the Medicare drug plans.

Rep. Henry Waxman, D-Calif., ranking minority member of the House Committee on Government Reform, has asked the Government Accountability Office to investigate the profits as a waste of taxpayer money.

In a Jan. 27 letter to GAO Comptroller General David M. Walker, Waxman wrote: "There appears to be no rational policy justification for providing this immense hidden subsidy to the drug industry.... It appears that the only party benefiting in this arrangement are the drug companies that give millions to the Republican leaders who drafted the legislation."

Waxman and other Democrats have long complained that Republicans withheld vital cost information about the program, allowed drug industry lobbyists to draft the proposal and fought efforts to have the government use its leverage to negotiate lower drug prices.

'Best We Could Accomplish'

During the Senate committee hearing Thursday, Sen. Rick Santorum, R-Pa., defended the Medicare drug plan as a flawed but worthy product of a political dogfight.

"It was the best we could accomplish given a very divided atmosphere here in Washington, D.C. So it is somewhat remarkable to expect that something that's the product of deep division, lots of haggling, lots of changes that occurred throughout the legislative process, is going to result in a perfect system," Santorum said.

Committee members Sen. Herb Kohl, D-Wis., and Sen. Hillary Clinton, D-NY, discounted McClellan's cost projections as premature.

Brand-name drugs purchased under Medicaid are discounted by at least 15 percent and they increase to up to 30 percent when inflationary rebates are added. Discounts negotiated by the private Medicare drug plans are expected to save 15 percent in 2006 and to peak at 25 percent in 2011, according to government estimates.

Those projections are based on enrollment assumptions and reflect the Bush administration's belief that competition among hundreds of different Medicare drug plans will ultimately drive down drug prices.

Medicare officials say that's already happening. "Based on the prices we've looked at, we believe the drug plans are getting better net prices than those paid under Medicaid," said Medicare spokesman Gary Karr. He said governors across the country have reported the same thing.

But Schondelmeyer said that's not the norm. He studied about 40 plans in one area of Minnesota and found that prices in each plan on 25 different drugs were within four percentage points of the regular retail drug prices. And most of the Medicare plan prices were 20 to 30 percent higher than the cost under Medicaid.

Schondelmeyer doesn't envision the Medicare program getting better prices than Medicaid at any point in the future because dozens of private plans won't have as much negotiating clout as a government-run program.

"The argument that more plans will be more competitive doesn't appear to be true. More players doesn't result in lower prices if they have much smaller volumes and much less leverage," Schondelmeyer said.