FRBSF Economic Letter
2007-18; July 6, 2007
The Costs and Value of New Medical Technologies: Symposium Summary
This Economic Letter summarizes the presentations
made at a symposium by the same title sponsored by the
for the Study of Innovation and Productivity and held at
the Federal Reserve Bank of San Francisco on May 25, 2007.
Health care is among the most technologically advanced
sectors, and it also constitutes a large and growing
share of the U.S. economy. Between 1960 and 2005, the share
health-care spending in U.S. gross domestic product more
than tripled, growing from 5.2% to 16%; this growth is
likely to continue, with health care conceivably expanding
to encompass up to one-third of national output by the
year 2050 (Jones 2005).
Much of this growth is demand driven, as purchasers of
health care spend increasing amounts of money to pay
for new, technologically advanced medical procedures and
that extend life and improve its quality. At the same
time, however, rising costs mean lower affordability: coverage
under private health plans, mostly through employers,
declined in recent years, putting added strain on already
strapped public programs (Buchmueller and Valletta 2006).
These trade-offs are likely to intensify over time, raising
a host of issues for policymakers and the public alike.
To help improve our understanding of how new medical
technologies contribute to the evolution of health-care
costs and how government policy may affect these trends,
the Center for the Study of Innovation and Productivity
convened a conference that brought together four leading
scholars to discuss various aspects of the development
and use of new medical technologies.
Responses to rising costs
Alan Garber, from Stanford University and the Palo Alto
VA hospital, presented his work on "Cost-Conscious
Coverage for Medical Innovation." His presentation
focused on the role that new medical technologies have
played in the rapid rise in health-care costs and how to
alter the incentives in U.S. health care so that costs
associated with new technologies are controlled but the
quality of services is not undermined. As U.S. health-care
costs have risen in recent years, out-of-pocket costs for
the insured have grown rapidly: for example, premium contributions
for workers covered under plans provided by their employers
grew about 50% between 2000 and 2003. Such cost sharing
has the potential to curb utilization, which may help contain
cost growth in an efficient manner. However, the overall
containment potential of cost sharing is limited because
the highest-cost claims account for a large share of total
spending and are relatively insensitive to cost sharing.
Moreover, increased cost sharing offsets the risk-protection
and risk-pooling intent of insurance plans.
Garber's preferred strategy for cost control relies on
modifying the process used to determine which medical
procedures and therapies are covered under insurance plans.
private and public health plans, this determination currently
is based on an assessment of whether the technology or
procedure yields greater improvement in health outcomes
than do established alternatives. This approach entails
various problems, including the possibility of mistaken
assessments due to limitations of accepted experimental
designs and statistical evaluations. Most importantly,
the existing framework for evaluating the effectiveness
of health interventions does not take into account considerations
of relative cost: procedures with similar impacts on
health outcomes can be regarded as equally meritorious
large differences in the costs of their use.
The exclusion of cost considerations likely has contributed
to rapid increases in U.S. health-care costs. Garber
therefore recommends the use of "cost-conscious coverage" policies,
whereby health interventions are evaluated in terms of
their relative cost effectiveness in addition to their
impact on medical outcomes (for example, Garber 2004).
Evidence on cost effectiveness of different health interventions
currently is available and could be used to initiate a
switch toward cost-based coverage, resulting in immediate
cost savings. Moreover, these savings are likely to grow
substantially over time, as health plan designers, consumers,
and medical innovators respond to the newly available information
and modified incentives.
Future medical technologies
Dana Goldman, a director at the RAND Corporation and
adjunct professor at UCLA, discussed his work on "The Costs
and Benefits of Future Medical Technologies." He first
established that expanding technology has been by far the
largest contributor to the rapid increase in health-care
costs since 1960, accounting for about one-half of the
increase. Like Garber, however, Goldman also emphasized
the large variation in benefit/cost ratios that is evident
across medical procedures. In an ongoing RAND research
study, his team models the effects of 34 key emerging medical
technologies, including anti-aging compounds, stroke treatments,
cancer therapies, and implantable heart defibrillators
and pacemakers (see Goldman et al. 2005). For example,
their model predicts that use of intra-ventricular cardio-defibrillators
(ICDs) will expand dramatically in coming years, adding
about $30 billion annually (3.7%) to U.S. medical spending
through the year 2030. This makes ICDs an expensive technology
relative to the value of resulting health improvements,
but other advanced technologies, such as certain cancer
treatments and pacemakers, are even more expensive.
In addition to their direct costs, medical innovations
can have large indirect costs. For example, medical researchers
currently are investigating the potential use of anti-aging
compounds in humans, which could substantially extend
life at relatively low cost. However, if such treatments
successful, the size of the U.S. elderly population will
swell, increasing the prevalence of old-age conditions
(such as heart problems) and leading to large increases
in overall health spending. Similar considerations apply
to preventive health therapies such as smoking cessation
and obesity control. Successful smoking cessation programs
will save lives but be relatively expensive, since they
entail limited savings in end-of-life treatments but
increases in other forms of old-age care. By contrast,
obesity control may not greatly lengthen life spans,
it is likely to produce substantial improvements in health
and well-being that enable reductions in health-care
more generally. The RAND model's predictions have important
implications for government entitlement programs, suggesting
that medical innovations are likely to increase Medicare
spending but may not adversely affect the financing of
the U.S. Social Security program.
Impacts of government programs
Fiona M. Scott Morton is a professor of economics at
the Yale School of Management. Her talk, titled "The Impact
of Government Programs on Pharmaceutical Prices and Innovation," addressed
pharmaceutical markets and the role of the U.S. government's
large Medicaid and Medicare programs. Within health care,
spending growth has been especially rapid for pharmaceuticals,
with innovation accounting for a large share of producer
and consumer expenditures. Moreover, the government share
of this market in the United States is large (about 50%)
and likely to grow. Medicaid is the state-managed program
to provide health care for low-income individuals. Drug
prices in the program initially are set based on market
prices, but with a 15% discount imposed on manufacturers.
Subsequent price increases are limited to the prevailing
inflation rate, unless a new form of the drug is introduced;
the new form may consist only of minor modifications in
dosage or packaging. Pharmaceutical companies specializing
in expensive Medicaid drugs therefore face substantial
incentives for frequent product modifications and high
prices, which reduces their private sector sales but yields
a higher price on Medicaid sales (with no quantity reduction
because Medicaid recipients do not pay for their purchases).
In recent research, Scott Morton finds direct empirical
evidence of such shifts in the composition and pricing
of prescription medications under the Medicaid program
(Duggan and Scott Morton 2006).
Scott Morton also discussed pricing decisions for the
new Medicare Part D prescription drug benefit, initiated
January 2006. Drug provision under Part D is similar
to provision under private sector plans, with participants
choosing among competing plans, drug makers competing
business, and participants paying a cost share (which
is heavily subsidized for low-income enrollees); however,
access to certain classes of drugs is guaranteed under
Part D plans. Although direct empirical evidence is not
yet available, it is likely that drug prices under Part
D plans will be similar to those in the private sector,
although deviations are likely among protected classes
In the public as well as the private sector, development
of cost-effective drug therapies faces substantial hurdles
due to a lack of targeted coordination between insurers
and health-care providers. Like the preceding speakers,
Scott Morton therefore emphasized the importance of developing
integrated frameworks for assessing the cost effectiveness
of health interventions.
Vivian Ho, from Rice University and the Baylor College
of Medicine, discussed her work on "Learning Effects
and the Diffusion of Medical Technology in a Regulated
Environment," which expanded on the earlier presentations
by addressing the issue of how best to use new technologies.
In particular, she focused on the well-known "volume-outcome" relationship
for medical procedures, in which hospitals and surgeons
that have greater experience with complex surgical procedures
typically obtain better outcomes from those procedures
(such as lower mortality rates). The two leading explanations
for this relationship are: (i) "learning-by-doing" (LBD),
which refers to the process by which repeated performance
(by surgeons and hospitals) increases knowledge and skill,
thereby directly improving quality; and (ii) "selective
referral," whereby hospitals that provide the highest
quality service will attract more patients. Explanation
(i) points toward beneficial effects of policies that encourage
hospital specialization in specific procedures, whereas
(ii) reverses the causation and undercuts arguments in
favor of such policies.
These two explanations are difficult to distinguish empirically.
Researchers have used volume changes over time for specific
hospitals in an attempt to separate out reverse causation,
but such studies are undermined by small changes in volume
over time and confounding effects from changing technology.
In recent work, however, Ho and colleagues (Gowrisankaran,
Ho, and Town 2007) used an "instrumental variables" strategy,
which relies on variations in procedure volumes across
hospitals that are uniquely determined by the choices of
individual patients. Their technique yields statistically
precise estimates showing a substantial impact of volume
on quality for several types of open heart and abdominal
surgeries, providing strong evidence in favor of LBD.
Ho's findings suggest that medical policy guidelines
that require or encourage hospitals to reach minimum volume
thresholds for complex procedures may be advantageous
patients. On the other hand, regulations that attempt
to capitalize on these gains may increase the market power
of the high-volume providers, leading in turn to higher
prices. In additional work, Ho and colleagues (Ho, Town,
and Heslin 2007) found that increased market power partially
offsets the value of health gains to patients, but substantial
net benefits to volume remain. Overall, her findings
that learning is an important element for the successful
use of new technologies, and that medical practitioners
and policymakers should more systematically account for
learning effects when developing health-care guidelines.
Among the common themes identified by the presenters,
it seems clear that advances in medical technology have
large benefits relative to their costs in the United
States in recent decades. However, incentive structures
the U.S. private and public systems for health-care delivery
are not always ideal: market power among providers sometimes
offsets consumer gains from new procedures, and cost
control generally is not rewarded. Achieving greater cost
will be technically and politically challenging because
it is likely to entail some degree of rationing in the
supply of health-care services, but explicitly making
such trade-offs may be necessary to ensure the spread of
medical technologies to the widest possible population.
[URLs accessed June 2007.]
Buchmueller, Tom, and Rob Valletta. 2006. "Health
Insurance Costs and Declining Coverage." FRBSF
Economic Letter 2006-25 (September 29).
Duggan, Mark, and Fiona Scott Morton. 2006. "The Distortionary
Effects of Government Procurement: Evidence from Medicaid
Prescription Drug Purchasing." Quarterly Journal
of Economics 121(1) (February) pp. 1-30.
Garber, Alan M. 2004. "Cost-Effectiveness and Evidence
Evaluation as Criteria for Coverage Policy." Health
Affairs Web Exclusive, May 19.
Goldman, Dana P., et al. 2005. "Consequences of Health
Trends and Medical Innovation for the Future Elderly." Health
Affairs Web Exclusive, September 26.
Gowrisankaran, Gautam, Vivian Ho, and Robert J. Town.
Learning, and Forgetting in Surgery." Working
paper, University of Minnesota.
Ho, Vivian, Robert J. Town, and Martin J. Heslin. 2007. "Regionalization
versus Competition in Complex Cancer Surgery." Health
Economics, Policy, and Law 2, pp. 51-71.
Jones, Charles I. 2005. "More Life vs. More Goods:
Explaining Rising Health Expenditures." FRBSF
Economic Letter 2005-10 (May 27).
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