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Lecture 11:
Pricing Pharmaceuticals
AEM 4160: Strategic Pricing
Prof. Jura Liaukonyte
2
Lecture Plan



QALY
Value of Statistical Life
HBS Case on Gardasil
Value of Statistical Life
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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.
VSL Studies Using CFOI Database
(VSLs in millions of dollars)
Study
1.
Viscusi (2003) *
Year of
Study $
1997
VSL in StudyYear $
$14.185M
VSL in
2012$
$21.65M
2.
Leeth and Ruser (2003) *
2002
$7.04M
$8.90M
3.
Viscusi (2004)
1997
$4.7M
$7.17M
4.
Kniesner and Viscusi (2005)
1997
$4.74M
$7.23M
5.
Kniesner et al. (2006) *
1997
$23.70M
$36.17M
6.
Viscusi and Aldy (2007) *
2000
7.
Aldy and Viscusi (2008) *
2000
8.
9.
10.
11.
Evans and Smith (2008)
Viscusi and Hersch (2008)
Evans and Schaur (2010)
Hersch and Viscusi (2010)
2000
2000
1998
2003
$9.6M
$7.37M
$6.7M
$6.8M
$12.84M
$9.86M
$9.85M
$8.43M
12.
Kniesner et al. (2010)
2001
$7.55M
$9.76M
13.
Kochi and Taylor (2011)*
2004
14.
Scotton and Taylor (2011)
1997
$5.27M
$8.04M
15.
Kniesner et al. (2012)
2001
$4M - $10M
$5.17M $12.93M
Comments
Implausibly high; industryonly risk measure
Occupation-only risk
measure
Industry/occupation risk
measure
Industry/occupation risk
measure
Implausibly high;
industry/occupation risk
measure
Industry-only risk measure;
no full-sample VSL estimate
Industry-only risk measure,
no full-sample VSL estimate
Industry-only risk measure
Industry-only risk measure
Industry-only risk measure
Industry/occupation risk
measure
Industry/occupation risk
measure
VSL estimated only for occupational drivers
Industry/occupation risk
measure; VSL is mean of
estimates from three
preferred specifications
Industry/occupation risk
measure; mean VSL estimate
is $9.05M
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 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
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
VSL is very important in policy.
Many government agencies have a VSL estimate that drives
their cost-benefit analyses or policy studies.

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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
Value of a Statistical Life and Compensating
Differences
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

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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
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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?

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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.

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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

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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

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
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:

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Cost per dose: ___________________
Cost per administration:_____________
Number of doses: _____________________
Total cost per patient: __________________
Step 2
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Additional QALYs per person

At age 50, further life expectancy without cervical cancer:______
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QALY per year: __________________________________________
Total QALYs: ____________________________________________
At age 50, further life expectancy with cervical cancer: ________
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QALY per year: ___________________________________________
Total QALYs: _____________________________________
Step 2
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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:

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Vaccination: _____________________________________
QALY: ____________________________________
Cost per QALY:___________________________
Step 2a

This was a rough calculation because it left out an
important piece of a puzzle:

COST SAVINGS
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Fewer Pap tests
Fewer LLETZ procedures
Fewer cervical cancers to treat
Step 2a

Calculate COST savings
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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):
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CIN 1: 50%
CIN 2: 70%
Cervical Cancer: 70%
Calculate Total Savings:
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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


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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

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$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
_____________________
_____________________
_____________________
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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_
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QALY per year: ______________________0.8______________
Total QALYs: _____________.8*31.6=25.2____________________
At age 50, further life expectancy with cervical cancer: 20 years__
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QALY per year: _______________0.8______________
Total QALYs: _________________0.8*20=16____________________
Step 2
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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:
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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):


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CIN 1: 50%
CIN 2: 70%
Cervical Cancer: 70%
Calculate Total Savings:
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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
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