Lecture Health economics - Chapter 1: Industry overview

Industry Overview

Health Economics
Professor Vivian Ho
Fall 2009


Health Care Expenditures in the
United States, 1960-2007
1960

1970

1980

1990

2000

2005

2007

Nominal health expenditures $27.5
(billions of dollars)

74.9

253.9

714.0

1,353.3

1,987.7

2,241.2

Annual rate of growth
-(average annual % change
from previous period shown)

10.5%

13.0

10.9

5.9

8.9

6.2

Nominal per capita health
expenditures

$148

356

1,102

2,813

4,790

6,697

7,421

Health expenditures as
percentage of GDP

5.2%

7.2

9.1

12.3

13.8

16.0

16.2

Source:
CMS Homepage: />

The Health Care Industry is
Rapidly Evolving
Advances in medical technology and drugs
are dramatically improving patient care
 But,

these improvements are costly

Aging U.S. population
% 65 years+
1950
8.1
1970
9.8
2008
12.8


The Health Care Industry is
Rapidly Evolving
Increased cost containment efforts
 Changes

in government reimbursement of health
care providers
 Private insurers are exercising more control over
patient care

Increased competitive pressures
 Mergers

of existing providers
 Entry of new competitors

Where are the most promising business


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


America’s Top 100 Fastest-Growing Companies
FORTUNE, September 29, 2008
100
RANK

COMPANY

EPS
GROWTH
RATE

REVENUES
(millions)

WHAT THEY DO

9

Intuitive Surgical

62%

753.7

Makes and services surgical robots that allow for
less invasive procedures

29

Natus Medical

57%

139.8

Makes products to detect, treat and monitor
newborn health conditions

64

Psychiatric
Solutions

44%

1686.0

Provides in-patient behavioral-health services in 27
states

66

Omnicell

26%

238.6

Sells devices for controlling, dispensing and
tracking medications in 1,100 hospitals

67

Kendle
International

44%

633.3

Provides support for clinical development,
regulatory affairs, biometrics, and late phase
projects

70

Health Extras

57%

2233.3

Manages 60,000 network pharmacies that process
prescriptions (now Catalyst Health Solutions)

76

Amedisys

43%

900.7

Provides home health care and hospice services

94

Allscripts
Healthcare
Solutions

46%

300.4

Develops software for doctors to reduce errors,

costs, and paper in charts, prescriptions and orders


PHARMACEUTICAL INDUSTRY
U.S. prescription drug expenditures reached
$228b in 2007
Industry highly dependent on research and
development (R&D)
 $897m

to bring a new drug to market

Aggressive marketing to physicians,
hospitals, pharmacists, and even the patient


PHARMACEUTICAL INDUSTRY
Pfizer
 $48.3b
 40.8%

in sales in 2008

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
Systems which manage the quality and
cost of patient care
Most common:
 Health

Maintenance Organization (HMO)

Consumer pays a fixed annual capitation fee, for
which HMO agrees to provide comprehensive
medical services
21% of U.S. population (64.5m) enrolled in 2009


MANAGED CARE
ADVANTAGE: If capitation fee > costs,
HMO keeps the profit
DISADVANTAGE: HMO responsible
for cost overruns
 Subject

care

to lawsuits if provides sub-optimal


WSJ 2/17/98


LONG-RUN KEY TO SURVIVAL

Be an efficient provider of highquality patient care


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


Valuing Human Life
Individuals make decisions everyday that
reflect how they value health and mortality
risks.
 Driving

a car

 Smoking
 Eating

a cigarette

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
Many of these decisions involve observable
market choices
 Purchase
 Working

of a safety device.

on a risky job.

These decisions involve implicit tradeoffs
between risk and money.
Economists can use data on these decisions
to construct the value of a statistical life
(VSL).


Valuing Human Life
Example: How much additional money must a firm
offer a worker to take on a risky job, versus one with
no risk?
To answer this question, one could compare the
average wages of risky jobs vs. non-risky jobs.
Working as a coal miner is more risky than working

as an investment banker, but investment bankers get
paid more.
One must examine the tradeoff between wages and
risks, holding constant all other factors that influence
pay.


Valuing Human Life
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(Earningsi) =α0 +α1(Educationi) + α1(Experiencei) +
α2(Management Positioni) + α3(Fatality Riskj) + εij
One can estimate this regression, and the estimate of
α3 can be used to derive a VSL.


Valuing Human Life
Suppose the estimated coefficient α3 = 300.
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.
If average earnings are $32,000 then the VSL
= $32,000 * 300 = $9,600,000


Valuing Human Life
U.S. Occupational fatality rates by industry, 2005

Data on worker
characteristics is
available from the
Bureau of the Census.
The Department of
Labor collects data on
fatal occupational
injuries by industry.

Industry

BLS, CES survey

Natural resources and mining

139.0

Mining

28.3

Construction

16.2

Manufacturing

2.8

Trade, Transportation, & Utilities

5.8

Wholesale Trade

3.5

Retail Trade

2.6

Financial Activities

1.2

Educational & Health Services

0.9

Fatality Rates Per 100,000 Workers


Valuing Human Life
Labor market data from the U.S. typically
finds a VSL $4m to $9m in year 2000 dollars.
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
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, 1985-2000
Agency

Regulation

Value 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
Should the VSL vary with:
 Age?
 Income?
 Country?

Conclusion
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
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