Transcript Document

Chapter 12: Hospitals
Chapter 13: The
Pharmaceutical Industry
Essentials of Health Economics
Hospitals
• Hospital care tends to be the most expensive
aspect of healthcare delivery
• Dominated by the private not-for-profit hospital,
the industry is responsible for more than onethird of all healthcare spending
• The changes that began in the 1980s pushed
hospitals to become competitive and profit
oriented
– This corporate mentality has led to extensive
local marketing, leveraging debt, multihospital
chains, and administrators earning salaries
rivaling corporate executives
The role of the Not-For-Profit
Organization in the Hospital Industry
• The Not-For-Profit Organizational Form
– A not-for-profit hospital does not have
shareholders in the typical sense of the term
• Equity capital does not come from the sale of
stock, but from donations
• Nature of Competition in the Not-For-Profit
Sector
– The popularity of the not-for-profit organizational
form in the hospital industry may seem a bit odd
given the dominance of the for-profit firm in the
rest of the United States economy
The role of the Not-For-Profit
Organization in the Hospital Industry
– A second argument is based on the notion
that profit-maximizing hospitals will not
undertake any activity where the marginal
revenue is less than the marginal costs
• Many argue that even with the preponderance of
not-for-profits in the industry, the profitmaximizing objective is a reasonable operating
assumption
– Decision making in a not-for-profit hospital
resembles decision making in a for-profit
hospital
Alternative Models of Hospital
Behavior
• Utility-Maximizing Models
– Decision makers in a not-for-profit hospital
maximize utility subject to a break-even
constraint
– The utility-maximizing approach assumes that
the hospital decision maker’s objective is to
be in charge of the largest or the highest
quality hospital possible given the resources
available
– In practice, the assumption of quality
maximization is merely a variant of profit
maximization (and cost minimization) to
support other objectives
Alternative Models of Hospital
Behavior
• Physician-Control Models
– If physicians are the relevant decision makers, they have
a stake in what combination of inputs is used
– Physician control leads to technical efficiency in
production, where the physician faces a zero price for
other inputs, and too many other inputs are used relative
to physician inputs
– The physician wants the hospital to price complementary
services in order to increase demand for physician
services
– Payment for hospital services is separated from payment
for physician services, making the physician neither
financially responsible to the hospital nor accountable to
the patient for the cost of the hospital portion of care
The Trend Toward Multihospital
Systems
• The Theory of Consolidation
– Mergers, acquisitions, and other forms of
consolidation occur in the hospital industry for
the same reasons that they occur in any other
industry
– Firms are said to experience economies of
scale when the long run average costs fall as
the size of the operation expands
• If economies of scale are to result in
improved efficiency, a number of technical
advantages must be realized.
The Trend Toward Multihospital
Systems
• The Empirical Evidence on Consolidation
– Most of the empirical research on the growth of
hospital systems and efficiency is based on data from
a time period when cost-plus reimbursements were
the standard practice
– As hospital reimbursement shifted from retrospective
to prospective payment beginning in the mid 1980s,
the efficiencies of the multihospital system have
become more evident
The Trend Toward Multihospital
Systems
• Marketing strategies, similar to the one used by
international franchises in the fast food industry,
have a goal to create a perception of standardized
quality in the minds of potential customers
• Consolidation activity presents a challenge to antitrust
policy
– If consolidation leads to efficiency gains, then patients
could benefit from higher quality care at lower prices
Drug Costs
• Chapter 13 will help you to understand why
drugs are priced as they are and to evaluate the
pros and cons of government regulation of the
pharmaceutical industry
• An understanding of the biopharmaceutical
industry requires us to study its market structure,
pricing policies, the effects of government
regulation, the effects of cost-containment
strategies of third party payers, and the role of
international competition
• Also considered are the effects of new drugs,
insurance coverage, and advertising on the
demand for prescription drugs
The Biopharmaceutical Industry
• Biotechnology, which involves research into the
nature of fundamental genetic material, is the
new entrant in the biomedical field
• Products developed by the pharmaceutical
industry have historically been based on
chemistry rather than biology, and new
pharmaceutical products are often called new
chemical entities (NCEs)
• The distinction is becoming blurred and both
industries are now producing therapeutic drugs
The Importance of Pharmaceuticals
• Even though pharmaceuticals still make up only
a small fraction of total healthcare expenditures,
the proportion devoted to these products has
been increasing rapidly in recent years
• Increases in expenditures are partly the result of
price increases and partly a result of increases
in quantity utilized
– The increase in quantity is a mixture of higher
utilization of existing drugs and the purchase
of new pharmaceuticals
Market Structure
• Industry Concentration
– The biopharmaceutical industry is far less
concentrated than is commonly believed and is better
described as monopolistically competitive
• Competition at the Product Level
– Although patent protection confers monopoly power in
the production of a drug over the life of a patent, most
brand name drugs experience some competition from
other drugs used to treat the same illness during their
period of patent protection
• Most new brand name drugs have at least one
fairly close substitute at the time of their
introduction into the market
Market Structure
• Effects of Firm Size on Research &
Development Productivity
– Larger firms, which conduct more
research projects, tended to also have
more productive research programs
• Larger firms were also found to be
more likely to undertake research that
integrates process improvements and
product development
Government Regulation of the
Pharmaceutical Industry in the United
States
• Regulation by the Food and Drug Administration
– Federal regulation of the quality of drugs marketed in
the United States began with the enactment of the
Pure Food and Drug Act in 1906 that created the FDA
– The passage of the Kefauver-Harris Act in 1962
greatly strengthened the FDA
• The Kefauver-Harris Act required a more stringent
regime of clinical testing to launch both NCEs and
generic versions of drugs already on the market.
The number of new drugs launched per year
declined after 1962
• Smaller firms suffered a decline in both their
research productivity and market share
Government Regulation of the
Pharmaceutical Industry in the
United States
• In 1971, the government added a proof of efficacy to the
requirements for the introduction of new drugs
– Overall requirements became more stringent, and by
the 1990s the average time from first application to
the FDA approval of a drug had risen to over nine
years
• The following schedule shows the average time required
for the development of an NCE in the late 1980s:
– Discovery of an NCE
– Preclinical animal testing
– File application for authorization for human testing
(approximate time for discovery, preclinical and
application approval: 3.5 years)
Government Regulation of the
Pharmaceutical Industry in the
United States
– Phase I clinical testing: test the effects on a limited
number of healthy volunteers—test absorption rate,
metabolic effects, etc. (average time: 15 months)
– Phase II clinical testing: administer drug to larger
sample of humans—those with conditions the NCE
is intended to treat (average time: 2 years)
– Long-term animal studies (usually concurrent with
human testing)
– Phase III clinical testing: large scale testing to
determine efficacy and side effects (average time: 3
years)
– New drug approval process (average time 2.5
years)
Drug Patents
• In the U.S., drug patents protect the
manufacturer for 20 years. However, it
should be remembered that patents are
applied for before clinical trials begin, so
the actual life of a drug patent is 7-12
years.
Liberalization of the FDA
Process
• Generic Drugs
– When patents expire on brand name drugs,
chemically equivalent copies of the drug can be
produced
– In 1984, the Waxman-Hatch Act was passed, which
allowed generic drugs to be introduced with much
less burdensome testing requirements
• Orphan Drugs
– The Orphan Drug Act was passed in 1983 and
defined orphan drugs as those used to treat rare
diseases (i.e., those with fewer than 200,000 cases)
– From 1998 to 2003, orphan drug prices rose by 40
percent per year compared with an increase of 15
percent per year in nonorphan drug prices
Liberalization of the FDA
Process
– In 2003, the Centers for Medicare and Medicaid
Services (CMS) reduced rates of reimbursement to
hospitals and doctors for most orphan drugs
• Compassionate Use of Experimental Drugs
– Criticism of the FDA’s conservative stance led to the
adoption of a new drug approval procedure in the
1980s, whereby experimental drugs awaiting approval
may be made available to physicians for limited use in
treatments for patients in advanced stages of disease
• The Prescription Drug User Fee Act of 1992
– Caused some acceleration of the approval process by
granting the FDA authority to collect fees from firms
when applications are filed and when they are
accepted
Requirement for Prescriptions
(Rx)
• A second type of regulation intended to promote
the safety of the general public is the
requirement that a wide range of drugs be
available to consumers only when prescribed by
a licensed physician
• The argument that the requirement of
prescriptions from physicians is not in the public
interest is made more plausible when one
observes the many near-equivalents to newer
prescription drugs that are available without
prescription in the over-the-counter (OTC)
market
Liberalization of the Rx
Requirement
• Beginning in the 1970s, the FDA began to allow the
conversion from prescription (Rx) status to OTC status for a
limited number of drugs when pharmaceutical companies
could prove that even misuse of the drug would not have
harmful effects
– Note: It is in the insurance companies’ (and the patients’)
best interests to promote OTC status for drugs because
the OTC drugs are not usually covered by insurance
• Effects of Regulation on Pharmaceutical Firms’ Success
– Firms with home countries that impose higher safety
standards in the introduction of new drugs into the
domestic market have been shown to benefit in their
command over market share in foreign markets
– In countries where approval of drugs has an efficacy
requirement, firms seem to direct more research toward
developing products that improve existing drugs
Demand for Pharmceuticals
• Effect of Increased Insurance Coverage for
Prescription Drugs
– Third party payment now routinely reimburses
a higher proportion of generic drug costs, as
opposed to brand name drugs, in an attempt
to make consumers and physicians more
cost-conscious
– Medicaid also reimburses only the price of the
generic drug when a generic is available
• In this way, insurance companies can affect
the balance of generic and brand name
drugs utilized by altering relative prices to
consumers
Demand for Pharmceuticals
• Effect of Direct Marketing to Consumers
– Since 1997, direct marketing of drugs to
consumers has been legal in the United
States
• This makes it possible for drug companies
to create a consumer demand for products
that physicians might not otherwise
recommend
– Direct marketing to consumers also provides
a greater incentive to develop lifestyle
products, such as treatment for hair loss or
sexual dysfunction
Pricing Issues
• Price Differentials between Brand Names and
Generic Drugs
– It is widely believed that generic drugs are sold for
lower prices than equivalent brand name drugs, even
when produced by the same company
• Discounting of Drugs to Third Party Payers
– Discounts to insurers below the retail price is a form
of price discrimination and one that has become
increasingly important in the United States in the age
of managed care.
• Pharmacy Benefit Management Firms
– Insurance companies also employ other firms to
negotiate for them. Pharmacy Benefit Management
firms (PBMs) have emerged as service institutions for
large insurance companies
Profitability of the U.S.
Pharmaceutical Industry
• Profits are often thought to be higher in the
pharmaceutical industry than in most other
industries in the United States
• Because the proportion of cost devoted to R&D and
the rate of technological change are substantially
higher in the pharmaceutical industry than in most
other industries, the return on equity tends to
exaggerate the profitability of pharmaceutical firms,
given the way R&D expenditures are treated on
corporate balance sheets
• Even in the case of drugs that receive FDA
approval, only a small proportion provide enough
revenue through sales to cover the R&D costs
incurred in their development
Summary
• At the end of the twentieth century, the United
States still led the world in the development of
new pharmaceuticals. This is in spite of the fact
that costs of developing new drugs had risen
dramatically at the same time that managed care
imposed downward pressure on the domestic
prices of new drugs.
• The flow of new products continues to stimulate
demand for pharmaceuticals, as does the
increase in third party prescription drug
coverage