Industry Overview Health Economics Professor Vivian Ho Fall 2009

Health Care Expenditures in the United States, Nominal health expenditures$ ,353.31,987.72,241.2 (billions of dollars) Annual rate of growth % (average annual % change from previous period shown) Nominal per capita health$ ,1022,8134,7906,6977,421 expenditures Health expenditures as5.2% percentage of GDP Source: CMS Homepage:

The Health Care Industry is Rapidly Evolving l Advances in medical technology and drugs are dramatically improving patient care  But, these improvements are costly l Aging U.S. population % 65 years

l Increased cost containment efforts  Changes in government reimbursement of health care providers  Private insurers are exercising more control over patient care l Increased competitive pressures  Mergers of existing providers  Entry of new competitors é Where are the most promising business opportunities? The Health Care Industry is Rapidly Evolving

Which category has the largest share of health care expenditures? l Hospital Care l Physician Care l Prescription Drugs

America’s Top 100 Fastest-Growing Companies FORTUNE, September 29, RANK COMPANY EPS GROWTH RATE REVENUES (millions) WHAT THEY DO 9Intuitive Surgical62%753.7Makes and services surgical robots that allow for less invasive procedures 29Natus Medical57%139.8Makes products to detect, treat and monitor newborn health conditions 64Psychiatric Solutions 44%1686.0Provides in-patient behavioral-health services in 27 states 66Omnicell26%238.6Sells devices for controlling, dispensing and tracking medications in 1,100 hospitals 67Kendle International 44%633.3Provides support for clinical development, regulatory affairs, biometrics, and late phase projects 70Health Extras57%2233.3Manages 60,000 network pharmacies that process prescriptions (now Catalyst Health Solutions) 76Amedisys43%900.7Provides home health care and hospice services 94Allscripts Healthcare Solutions 46%300.4Develops software for doctors to reduce errors, costs, and paper in charts, prescriptions and orders

PHARMACEUTICAL INDUSTRY l U.S. prescription drug expenditures reached $228b in 2007 l Industry highly dependent on research and development (R&D)  $897m to bring a new drug to market l Aggressive marketing to physicians, hospitals, pharmacists, and even the patient

PHARMACEUTICAL INDUSTRY l Pfizer  $48.3b in sales in 2008  40.8% of sales come from 4 drugs: Lipitor, Lyrica, Celebrex, Norvasc.

PHARMACEUTICAL INDUSTRY The Wall Street Journal Online April 6, 2005 Pfizer Plans a Revamp And $4 Billion in Cost Cuts Drug Giant Scales Back Earnings Estimates, Citing Patent and Safety Woes

MANAGED CARE l Systems which manage the quality and cost of patient care l Most common:  Health Maintenance Organization (HMO) l Consumer pays a fixed annual capitation fee, for which HMO agrees to provide comprehensive medical services l 21% of U.S. population (64.5m) enrolled in 2009

MANAGED CARE l ADVANTAGE: If capitation fee > costs, HMO keeps the profit l DISADVANTAGE: HMO responsible for cost overruns  Subject to lawsuits if provides sub-optimal care

WSJ 2/17/98

LONG-RUN KEY TO SURVIVAL v Be an efficient provider of high- quality patient care

 Can we apply the tools of economics to study the health care sector?

Valuing Human Life l Individuals make decisions everyday that reflect how they value health and mortality risks.  Driving a car  Smoking a cigarette  Eating a medium-rare hamburger Note: These slides draw from material in Viscusi WP and Aldy JE, “The Value of a Statistical Life: A Critical Review of Market Estimates Throughout the World,” The Journal of Risk and Uncertainty 2003; 27(1): 5-76.

Valuing Human Life l Many of these decisions involve observable market choices  Purchase of a safety device.  Working on a risky job. l These decisions involve implicit tradeoffs between risk and money. l Economists can use data on these decisions to construct the value of a statistical life (VSL).

Valuing Human Life l Example: How much additional money must a firm offer a worker to take on a risky job, versus one with no risk? l To answer this question, one could compare the average wages of risky jobs vs. non-risky jobs. l Working as a coal miner is more risky than working as an investment banker, but investment bankers get paid more. l One must examine the tradeoff between wages and risks, holding constant all other factors that influence pay.

Valuing Human Life l Dataset with observations on workers, their annual Earnings, worker characteristics, job characteristics, including the risk of dying on the job in that worker’s industry. Ln(Earnings i ) =α 0 +α 1 (Education i ) + α 1 (Experience i ) + α 2 (Management Position i ) + α 3 (Fatality Risk j ) + ε ij l One can estimate this regression, and the estimate of α 3 can be used to derive a VSL.

Valuing Human Life l Suppose the estimated coefficient α 3 = 300. l This implies that a worker requires 300 times more earnings for a job with a 100% fatality risk versus a job with a 0% fatality risk, holding all other factors constant. l If average earnings are $32,000 then the VSL = $32,000 * 300 = $9,600,000

Valuing Human Life l Data on worker characteristics is available from the Bureau of the Census. l The Department of Labor collects data on fatal occupational injuries by industry. U.S. Occupational fatality rates by industry, 2005 IndustryBLS, CES survey Natural resources and mining139.0 Mining28.3 Construction16.2 Manufacturing2.8 Trade, Transportation, & Utilities5.8 Wholesale Trade3.5 Retail Trade2.6 Financial Activities1.2 Educational & Health Services0.9 Fatality Rates Per 100,000 Workers

Valuing Human Life l Labor market data from the U.S. typically finds a VSL $4m to $9m in year 2000 dollars. l One can also estimate a VSL based on the prices that people pay for safety devices that reduce the risk of death.  Price of smoke detectors vs. reduction in fire fatality risks.  Premium paid for areas with low air pollution vs. reduction in death from clean air.  Price of children’s car seats vs. reduction in auto fatalities when in use.

Policy Implications l U.S. agencies are required to compare the costs of proposed regulations to the benefits, which are often in terms of lives saved. Values of a statistical life used by U.S. Regulatory Agencies, AgencyRegulationValue of a statistical life (millions, 2000 $) Federal Aviation Administration Protective Breathing Equipment$1.0 Food & Drug Administration Regulations Restricting the Sale & Distribution of Cigarettes & Smokeless Tobacco to Protect Children & Adolescents $2.7 Environmental Protection Agency National Ambient Air Quality Standards for the Ozone $6.3

Policy Implications l Should the VSL vary with:  Age?  Income?  Country?

Conclusion l Because resources are limited, health economists are concerned with determining what medical services to produce, how they should be produced, and who should receive them l As we will see in this course, the tools of economics can be applied to the health care sector to derive valuable insights about our health care system