By Tunde Szabo, senior economist in the life sciences division of the European Investment Bank.
With “Mary Poppins Returns” in theatres, we are reminded of how the whole story started. A short recap: After unsatisfactory experiences with previous nannies, siblings Jane and Michael write an ad of their own to find a new one – an ad that their father tears up and throws in the fireplace, and that later mysteriously ends up in the hands of Mary Poppins, who shows up at their door.
One of the qualifications the kids put in the ad (in addition to having ‘rosy cheeks’) was that the new nanny should be someone who would “never give us castor oil”. Now, castor oil (or cod liver oil, in some versions of the story) was often given to kids as medicine. While castor oil does work as a laxative, and cod liver oil provides Vitamin D, both were believed to be good for you in all sorts of ways. But, more importantly, both taste foul – so foul, that avoiding the medicine made the list of requirements for the new nanny.
As adults we’ve become accustomed to accepting some foul-tasting medicine as long as we know that suffering through that spoonful will save us from discomfort – or worse – in the future. That is how we look at our health investments. Long-term thinking and strategy is required for smart investments today, to transform our health systems for better ones in the future. However, spending on health care is economically sustainable only up to the point at which the social cost of health spending exceeds the value produced by that spending.
Financial versus economic sustainability
In short, we are willing to swallow health care costs as long as we see that those investments will be beneficial in terms of people remaining healthy, productive and able to contribute to society. This means looking beyond a strictly financial return on healthcare investments.
From an economic perspective, healthcare facilities can be viewed as enterprises producing a number of services, at a certain cost, and generating both tangible and intangible benefits for the society. At the same time, both the costs incurred and the benefits obtained will be present in two forms: financial (those that enter into the business cash flow) and economic (those that concern the whole society, often intangible and thus more difficult to measure).
For appraising investments in the healthcare sector, EIB’s Life Sciences team performs both financial and economic analyses. Both types of analysis have similar features in the sense that both estimate the net-benefits of a project based on the difference between the “with-investment” and the “without-investment” scenarios. However, the financial analysis compares the benefits and costs to the enterprise, while the economic analysis compares the benefits and costs to the whole society.
Financial versus economic benefits
Large investments in the healthcare sector –the kind of projects the EIB typically deals with – sometimes fail to deliver sufficient financial returns, despite generating significant economic benefits for the society. From the entirety of economic sectors having received EIB-support, health care is perhaps the one carrying the greatest difference between financial and economic profitability.
Healthcare investment projects typically generate moderate financial benefits, but significant ones in terms of lives saved, new infections or diseases avoided, quality-adjusted life-years (QALYs) gained, loss of working days avoided, etc. Those economic benefits have an intrinsic monetary value. The problem is that it usually very difficult to measure that value, despite repeated attempts by national and international institutions to come up with some benchmarks.
For instance, QALY is a generic measure of disease burden, including both the quality and the quantity of life lived. It is commonly used in economic evaluation of medical interventions. One QALY equates to one year of human life in perfect health. To illustrate a typical benchmark for the monetary value of a quality-adjusted life-year (QALY) gained, we can look at estimates by the World Health Organization (which are, at the same time, based on the population’s perceived “average willingness to pay” for a given expected benefit). Quality-adjusted life-year has been estimated to be approximately 1-3 times the per capita GDP of the country.
Further example is the development of a vaccine that often requires large initial investments (properly equipped and staffed medical research institutions, followed by massive intangible investments in research activities). These investments may or may not financially pay out over a reasonable period, as buyers of that vaccine (usually governments) might not be able to pay the full/ correct price the market would normally demand. Therefore, the allocation of investments in vaccine development by a free market would not efficient, which would lead to a net social welfare loss and a consequent market failure. The EIB has a significant role in addressing such market failures.
Challenges of economic analysis
A strict financial appraisal of a healthcare project may give preference to projects designed to maximize profits, which possibly benefit from particular sociodemographic features or take advantage of specific provisions in the health insurance scheme. The problem with this approach is that it may leave the treatment of less “profitable” patients or treatments not paid for by private insurance to the governments. As has been observed numerous times, the health sector is an area where the market fails to efficiently allocate the available resources1. A healthcare provider, therefore, cannot be required to be “profitable” at all times.
Therefore, a pure financial analysis is not sufficient to appraise a specific healthcare investment project for EIB financial support. It needs to be combined with an economic analysis, taking into consideration the benefits of the investment for the society as a whole.
Multi-criteria analysis is the tool that we at the EIB use to capture health care’s complexity. The analysis is essentially a checklist of several quantitative and qualitative indicators that could not otherwise be summed up in one single number – be it the economic net present value or economic rate of return.
Why is how we evaluate healthcare investments so important? Mostly because of the huge pressure governments are under as the health costs continue to rise. There are four main reasons for this:
- Population growth. The global population has grown from 1 billion in 1800 to 7.6 billion in 2018, and keeps growing at about 1% per year. Estimates have put the total population at 8.6 billion by mid-2030, 9.8 billion by mid-2050 and 11.2 billion by 2100.
- Population aging. Based on official UN data, the number people aged 60 years or over (currently below 1 billion) is expected to more than double by 2050 and to more than triple by 2100. Globally, the percentage of the population aged 60 or over is growing faster than all younger age groups. By 2060, the average life expectancy in the EU will have risen from 77 years (2008 data) to 85 for men and from 82 to 89 for women. Better healthcare is allowing people to live longer, and more older people are using more healthcare services. Pensions for these older people will have to be financed by the working-age population, whose numbers are dwindling by comparison.
- Technological advances. Innovation is allowing us to live longer – and better – but at a cost. We are able to treat conditions more effectively, which therefore create an incentive to spend money on those treatments.
- Rising household income levels. With less people living in poverty, more people are able to afford healthcare services.
Without measures to contain costs, expenditures on public health and long-term care as a percentage of GDP, would more than double across OECD countries by 2060, increasing from 6.2% to 13.9%2. Even if policies are implemented to rein in cost, public health and long-term expenditure are still projected to reach 9.5% of GDP.
So is that bitter pill worth swallowing? If economic sustainability means that rising healthcare costs are justified as long as they improve lives, and we assume that all that value is captured in the GDP, then the spending may be justified. However, if we are happy with the quality of life that the current health spending provides, and if health care costs outpace the gains in GDP, then spending appears to be economically unsustainable.
The EIB does not have the powers of Mary Poppins. We cannot just give Michael and Jane some castor oil and make it taste like lime cordial or strawberry. However, we are also not the kind of the bank that Jane and Michael’s dad worked at.
We do have the power to give priority to healthcare projects with the highest expected economic value for society – by analysing and measuring the direct and indirect outcomes of the projects. We have significant market power: Since 1997, when the EIB was first given a mandate to lend to the health sector, the Bank has invested close to EUR 30 billion. Those funds have supported different types of interventions: from primary care networks and general hospitals to university hospitals and advanced medical research, both in the public and private sectors. We can also push EU promoters of healthcare projects to use best practices. Whether all this will be the ‘spoonful of sugar’ that will help medicine advance – well, we hope so.