Lecture 12 Pricing Pharmaceuticals

Lecture Plan QALY Value of Statistical Life HBS Case on Gardasil

Value of Statistical Life An economic value assigned to life in general. Marginal cost of death prevention in a certain class of circumstances. As such, it is a statistical term, the cost of reducing the (average) number of deaths by one.

Viscusi. “The Value of a Statistical Life: A Critical Review of Market Estimates Throughout the World.” Journal of Risk and Uncertainty, v. 27 issue 1, 2003, p. 5.

Value of Life and Compensating Differences Calculating VSL may sound callous or morbid, but it can lead to stronger safety and environmental regulations For example, auto safety rules that would cost $100 million to implement but might protect $500 million worth of lives (say, 100 people at $5 million of VSL) are seen as a good deal, cost-benefit-wise. VSLs can vary widely, depending on the agency and the administration in office, usually $5- $9 million.

Controversial? Some economists have suggested that we need to be clearer about the fact that we’re not talking about Fred’s life but a change in population mortality risk, we should use a different word, like “micromort” (as argued in Cameron, 2010). There’s a mathematical sense in which the two ideas are identical—if we’re increasing deaths by one, why should it matter whether the person who dies is identifiable or not? However, while people seem willing to trade off population mortality risk against other things, people have a visceral ethical reaction to valuing Fred’s life.

VSL VSL is very important in policy. Many government agencies have a VSL estimate that drives their cost-benefit analyses or policy studies. US Environmental Protection Agency uses a value of $8.5 million in 2012 dollars The US Department of Transportation uses a value of $6.4 million When these agencies analyze policies that have been or may be enacted, they use these numbers to value changes in risks to lives. For example, the EPA’s assessment of a revised air pollution rule (the Cross State Air Pollution Rule) found that the rule provides much larger benefits than costs, and this conclusion is largely driven by reductions in mortality risks

VSL The idea is that if we can find out the exact amount a person is willing to pay (or accept) to avoid (or allow) an increase in risk of death of ∆p, then we can extrapolate to figure out how much you’d pay (or accept) to avoid (allow) certain death. Therefore if the WTP or WTA amount is ∆X, then we can say that:

VSL Safety devices: E.g., fire alarms have an annualized cost of $20 they reduce risk of death by 1 in 100,000 per year. By buying the smoke alarms, people are demonstrating that they value their lives enough to make that tradeoff. So these people must value their lives at least as much as: Sprinkler systems: E.g. people are generally unwilling to buy sprinkler systems. These people might not value their lives enough to make that tradeoff. If a sprinkler system has a cost of $1000 but it reduces the risk of death by 1 in 10,000, then:

Value of a Statistical Life and Compensating Differences Qa , Qb =probability of fatal injury on job a, b respectively in a given year Wa, Wb = earnings on job a, b in a given year Assume Qa<Qb so that Wa<Wb Compensating difference=Wb-Wa Value of a “statistical” life = (Wb-Wa)/(Qb-Qa) Example: If a person is faced with .001 higher risk of death per year and is paid $5000 per year extra for that risk, the value of a statistical life is 5000/.001 - $5,000,000

Value of Life and Compensating Differences Four biases in estimates of statistical value of life Valuation is correct only for “marginal” worker. Estimate is too high for infra-marginal worker, and too low for workers that didn’t accept job with risk. Ex post versus ex ante rewards for risk (compensating difference vs. law suits, insurance, etc.) Failure to control for other risks correlated with fatality risk Fatality risk measured with error

Value of a Statistical Life and Compensating Differences

Question Is Gardasil a Good Product?

Pricing in the Biomedical Industry What factors should Merck consider when setting the price?

Factors: Important or not important? Product cost R&D Investment? Other Vaccines? Public Relations? Value to the Customer/Benefit? Economic Modeling? Competition?

Pharmaceutical Market Prescription medicines are subject to derived demand. Products demanded and sold in response to medical need. Their use is affected by recognized standards of care Essential decision maker is the physician who neither consumes nor pays for the product Prescriptions are considered “negative goods”, in that those who purchase or consume them would prefer not to do so. Prescriptions are experience goods. Their actual utility cannot be determined until they have been used.

QALY The quality-adjusted life year (QALY) is a measure of disease burden, including both the quality and the quantity of life lived. It is used in assessing the value for money of a medical treatment. The QALY is based on the number of years of life that would be added by the treatment. Each year in perfect health is assigned the value of 1.0 down to a value of 0.0 for death.

QALY Used in cost-utility analysis to calculate the ratio of cost to QALYs saved for a particular health care treatment. Helpful in allocating healthcare resources Treatment with a lower cost to QALY saved ratio being preferred over an intervention with a higher ratio Controversial: some people will not receive treatment because it is too costly Cost per QALY under $50,000 is acceptable

Calculating Cost per QALY Cost Per QALY = Cost of a quality life year Step 1: Consider the costs per person: Cost per dose: ___________________ Cost per administration:_____________ Number of doses: _____________________ Total cost per patient: __________________

Step 2 Additional QALYs per person At age 50, further life expectancy without cervical cancer:______ QALY per year: __________________________________________ Total QALYs: ____________________________________________ At age 50, further life expectancy with cervical cancer: ________ QALY per year: ___________________________________________ Total QALYs: _____________________________________

Step 2 Reduction in QALYs with cervical cancer:_________________ Gardasil prevents:______________________________ Gardasil incremental QALYs: ________________ Chance of Getting cervical cancer without Gardasil: _________ Incremental QALYs per person: _______________________ Cost per QALY: Vaccination: _____________________________________ QALY: ____________________________________ Cost per QALY:___________________________

Step 2a This was a rough calculation because it left out an important piece of a puzzle: COST SAVINGS Fewer Pap tests Fewer LLETZ procedures Fewer cervical cancers to treat

Step 2a Calculate COST savings Chance that a woman will have CIN 1: ______________ Chance that a woman will have CIN 2/3:______________ Chance that a woman will have cervical cancer: ___________ Cost to treat CIN 1: ________$55______________ Cost to treat CIN2/3: _____________________ Cost to treat cervical cancer: ________________

Saved Costs per person CIN 1: __________________________________ Cervical cancer: ___________________________ Gardasil will prevent (estimates): CIN 1: 50% CIN 2: 70% Cervical Cancer: 70%

Calculate Total Savings: CIN 1: ____________________ CIN 2/3: ____________________ Cervical cancer: _________________ TOTAL SAVINGS: ______________________

Savings Now or Later? Vaccine given (average or target): __________ Cancer prevents: _______________ Difference: ___________________ Discount the cost savings at say, 8% = $16.50 In excel the command would be: =PV(0.08, 43, ,-450.2)

Savings later So the total is: Cost per person: _______________ Savings per person: ___________ QALY per person: 0.038 COST per QALY:__________________ Do the risks of a PR backlash and the need to grow quickly outweigh the benefits of a higher price Potential entrant is coming (Cervarix approved by FDA in 2009) Patent is not forever

$360 Too Low or Too High? Suppose prices are set so that cost of QALY is $30,000 What is the maximum price that could be set? x = cost per person _____________________

ANSWERS TO BLANK SLIDES

Calculating Cost per QALY Cost Per QALY = Cost of a quality life year STEP 1: Consider the costs per person: Cost per dose: ____________$120_______ Cost per administration:______$20________ Number of doses: _________3____________ Total cost per patient: ________$420_______

Step 2 Additional QALYs per person At age 50, further life expectancy without cervical cancer: 31.6 years_ QALY per year: ______________________0.8______________ Total QALYs: _____________.8*31.6=25.2____________________ At age 50, further life expectancy with cervical cancer: 20 years__ QALY per year: _______________0.8______________ Total QALYs: _________________0.8*20=16____________________

Step 2 Reduction in QALYs with cervical cancer:___25.2-16=9.2___ Gardasil prevents:__________________70%____________ Gardasil incremental QALYs: _______.7*9.2=6.4_________ Chance of Getting cervical cancer without Gardasil: ___0.6%_ Incremental QALYs per person:____0.006*6.4=0.038_______ Cost per QALY: Vaccination: ___________________$420__________ QALY: ________________________0.038____________ Cost per QALY:_________________420/0.038=$11,053__________

Step 2a This was a rough calculation because it left out an important piece of a puzzle: COST SAVINGS Fewer Pap tests Fewer LLETZ procedures Fewer cervical cancers to treat

Step 2a Calculate COST savings Chance that a woman will have CIN 1: _______10%__ Chance that a woman will have CIN 2/3:___2.8%___ Chance that a woman will have cervical cancer: __0.6%_____ Cost to treat CIN 1: ________$55______________ Cost to treat CIN2/3: _________$1400____________ Cost to treat cervical cancer: _______$100,000_________

Saved Costs per Person CIN 1: ________10%*$55=$5.50____________ Cervical cancer: __0.6%*$100,000=$600_____ Gardasil will prevent (estimates): CIN 1: 50% CIN 2: 70% Cervical Cancer: 70%

Calculate Total Savings: CIN 1: ________5.50*50%=$2.75____________ CIN 2/3: ______39.20*70%=$27.44__________ Cervical cancer: __600*70%=$420___________ TOTAL SAVINGS: _____$450.20______

Savings Now or Later? Vaccine given (average or target): ___Age 11____ Cancer prevents: _____Age 54_____ Difference: _________43 years______ Discount the cost savings at say, 8% = $16.50 In excel the command would be: =PV(0.08, 43, ,-450.2)

Savings Later So the total is Cost per person: ________$420_______ Savings per person: ______$16.50_____ QALY per person: 0.038 COST per QALY: $10,618.00 Do the risks of a PR backlash and the need to grow quickly outweigh the benefits of a higher price Potential entrant is coming Patent is not forever

$360 Too Low or Too High? Suppose prices are set so that cost of QALY is $30,000 What is the maximum price that could be set? x = cost per person (x-16.50)/0.038 = 30,000 x =$1156.5 Or $1156.5/3 = $385 per dose