Differentiating Health Care Costs from Health Care Value

Differentiating Health Care Costs from Health Care Value

The wrong model, no matter how hard you work it, will never provide the right answer. When it comes to how we pay for health care, the U.S. is using the wrong model. What’s worse, these financing inadequacies could threaten the viability of new therapies that will bring hope to patients who formerly had none. The well-being, and sometimes the lives of patients, depend on getting the health care financing model correct.

New gene therapies will transform the treatment of devastating diseases. For instance, a gene therapy that will treat spinal muscular atrophy (SMA), Zolgensma, will likely receive FDA approval in May 2019. SMA is a muscle wasting disease. Children with type I SMA will typically die before they turn two; while children with type II or type III SMA can have normal life expectancies, but will be unable to stand, and experience weakness in the muscles of their arms and legs throughout their lives.

Zolgensma could revolutionize treatment. Indications are that Zolgensma will dramatically improve patients quality of life and more effectively manage the disease with just one treatment. Revolutions rarely come cheap, and the cost of this new gene therapy will likely resemble the cost of a heart transplant, not traditional medicine.

With such an expensive price tag, the value of these therapies must also be high. Trying to determine the value of these therapies is no easy task, which is complicated further by the structural inefficiencies of the current health care system. Organizations, such as the Institute for Clinical and Economic Review (ICER) attempt to answer this question by conducting cost-effectiveness studies.

Cost-effectiveness studies are, by definition, a means for rationing care. They employ arbitrary assumptions, such as how much should be spent to enable a person to live one additional quality-adjusted life year. Of course, this requires someone to define what a “quality adjusted life year” is. Ultimately, as the long wait times in the U.K. demonstrate, countries that use cost-effectiveness studies to determine a therapy’s value end up rationing care.

In practice, cost-effectiveness studies fail to account for the full systemic costs associated with diseases, as well as the unquantifiable costs patients, and their families, living with diseases must endure. Patients living with SMA, for instance, have significantly higher annual health care expenditures for their entire lives, not to mention annual treatment costs up to $375,00 ($750,000 for the first year). A therapy that works with one treatment, and consequently avoids all of these other costs, undoubtedly creates a tremendous amount of value.

The value of gene therapies cannot be defined by avoided costs alone. There is a tremendous amount of value from a therapy that helps children with type I SMA live past their second birthday and enables children and adults with type II and III SMA to live healthier lives. Empowering a board to put a price tag on these benefits contradicts the entire purpose of health care. Ultimately, this is why the cost-effectiveness framework is the wrong model to determine the value of a medicine.

Instead of defining the problem in terms of cost-effectiveness, it is more fruitful to approach the problem from an insurance/reinsurance perspective. While the U.S. health insurance market currently does a poor job, the purpose of any insurance product is to transfer risks from the insured to the insurance company.

This risk transfer works because not everyone will experience the bad outcome, but people want to be protected from the full financial consequences of those risks should the bad outcome occur.

Applied to SMA, there are around 400 to 500 babies in the U.S. who will be born with SMA every year. While at a 32-year low, there were still 3.78 million babies born in the U.S. during 2018. Based on the higher SMA estimate, this means SMA afflicted a tiny fraction of all babies born – 0.01%.

While the possibility that any one of these parents has a baby born with SMA is very small, the risk exists. According to the Wall Street Journal, the new gene therapy to treat their baby could cost $2 million. Without insurance, such a cost is prohibitive.

The purpose of insurance is to spread these large potential costs across a broad spectrum of people. Since we are unsure which health risks we might face, people are willing to pay a fraction of the cost to ensure that if their family is unlucky enough to have a baby diagnosed with SMA that the costs will be covered. Spread over a large enough population (likely requiring effective re-insurance, a point addressed below), the $2 million treatment cost is manageable.

As a back-of-the-envelope calculation, if there are 500 babies born with SMA, and at a cost of $2 million per treatment, this indicates the total annual costs for treating these children will be $1 billion. There are, however, 294.6 million insured Americans. Spread across this entire population, the per insured costs are only $3.39.

While this is not the actuarially correct methodology, it is indicative. This low per-insured expenditure is enabled by spreading the costs across the entire insured population. And, this is where an effective re-insurance market arises. Re-insurance provides insurance services to insurance companies. Effective re-insurance markets enable insurers to effectively manage their risks and spread the costs across an even larger population.

The current regulations are thwarting efficient health insurance markets, or the development of an effective re-insurer, that will efficiently cover the costs associated with the expensive high-value treatments like gene therapies.

Creating an efficient insurance/reinsurance market will create many other benefits for the health care system writ large. Paramount among these, an efficient insurance market would eliminate the inefficiencies that plague the “demand-side” of the health care sector. With a more efficient demand-side, price negotiations could better reflect the relevant costs helping ensure that both innovation and competition are simultaneously incented.

The coming gene therapies will revolutionize health care, but to fully benefit from these treatments our current approach to financing health care must change. The growing trend to use cost-effectiveness as a benchmark will limit access and discourage continued innovation. The best way to encourage the development of 21st-century medical treatments is to effectively apply traditional insurance principles to the health care market.

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