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Lecture 11: Pricing Pharmaceuticals AEM 4160: Strategic Pricing Prof. Jura Liaukonyte 2

Lecture Plan  Guest Lecture  HW3, HW 4  QALY  Value of Statistical Life  HBS Case on Gardasil

Guest Lecture – Thursday, March 12  2:55PM in WN B50 (No class at 1:25PM)  Seth Sarelson, COO Revtrax  2004 Dyson graduate; Co-founder of Revtrax  Bridging the gap between digital media and in-store sales  Analytics, direct response marketing, coupons, affiliate marketing, loyalty & rewards programs.

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

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.

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/ $5,000,000

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.

Value of a Statistical Life and Compensating Differences

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

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?

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: __________________________________  CIN 2/3: ________________________________  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:  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:___ =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____________  CIN 2/3: ______2.8% * $1400=$39.20_______  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:  COST per QALY: $10,  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 $30,000  What is the maximum price that could be set?  x = cost per person  (x-16.50)/0.038 = 30,000  x =$  Or $1156.5/3 = $385 per dose