Interface Between Risk Assessment and Economics: Economic Valuation Methods

Presentation to IRAC Conference

Risk Assessment, Economic Analysis, and Foodborne Illness Regulations

Al McGartland, USEPA

November 16, 2007

The opinions in this presentation do not necessarily represent those of EPA.

2

1990s

Evolution of Risk Assessment at EPA

1970s

beginnings of the field of risk assessment emphasis on oral route per FDA precedent

1980s

adopt RA/RM paradigm guidelines & basic methodologies data bases (IRIS)

new tools/data bases refinement of existing tools understanding mechanisms

of action/interactions ecological assessment

2000s

complex mixtures sensitive subpopulations non-linear dose-response input into economic analysis

3

Roles of Risk Assessment

Risk Assessment - cancer - non-cancer

Policy Decision - standards - information

Risk Assessment Risk Management

Protective

4

Roles of Risk Assessment

Risk Assessment - cancer - non-cancer

Policy Decision - standards - information

Risk Assessment

Economic Analysis- benefit-cost analysis- cost effectiveness- economic impacts

Risk Management

Protective

Predictive

5

Damage Function Approach

• Benefits analysis draws upon results of other disciplines

• Simplified linear process of benefits analysis, but there may be feedback loops – For example, changes in individual behaviors

evaluated in the benefits “box” may have implications for emissions or exposure

Emissions Environmental

Concentrations

Exposure

Effects(dose-response)

Benefits($ for each effect)

6

From Risk Assessment to Economics

• Should focus on well-defined health endpoints that have an effect on individual sense of well-being.– “hormone level” vs. hypothyroidism

• Should be probabilities to represent the expected changes in risk to an individual– probabilities not thresholds

– upper bound risk estimates

• Should provide information on when risks change due to exposure changes – substantial lags between exposure and cancer

7

Health Science Inputs and Economic Valuation

• Epidemiological data are preferred for valuation in policy analysis– observed health effects in humans– incorporates behavioral responses

• Results from animal studies may be used– Cancer dose-response: risk estimates are still usable although their

applicability can be a concerns (e.g, upper-bound estimates)– Non-cancer risk assessment: Reference doses and other measures

that don’t estimate probabilities cannot be utilized in benefits analysis

8

Cancer vs. Non-Cancer Benefits

9

Economic Analysis

PredictiveRisk Assessment

Data

Cost of Illness

Willingness to Pay

QualityAdjustedLife Years

DisabilityAdjustedLife Years

Cost-Effectiveness

Analysis

Benefit-CostAnalysis

Analytic Approach

Health Value Measure

10

Economic Analysis

PredictiveRisk Assessment

Data

Cost of Illness

Willingness to Pay

QualityAdjustedLife Years

DisabilityAdjustedLife Years

Cost-Effectiveness

Analysis

Benefit-CostAnalysis

Analytic Approach

Health Value Measure

11

Benefit-Cost Analysis

• Simulates the private market test for public goods– BCA quantifies all benefits and costs of producing environmental

protection– Consistent with private markets, the efficient outcome is the option

that maximizes net benefits– BCA is, therefore, an efficiency test for the production of environmental

protection

.

12

Benefits

• Rules for determining the benefit, or value, of environmental protection are the same as those in the private market – quantify the willingness to pay for the environmental commodity

• Value is determined by what consumers are willing to pay for a commodity, not what the analyst believes the value to be– Economists look to see what values society places on environmental goods

– Analysts do not assign their own values

• Because environmental protection it is a public good, the benefits of a policy are the sum total of each affected individual’s willingness to pay for the policy

13

Values for use in Benefit-Cost Analysis

Cost of illness ($)

• Each avoided health effect converted to $-equivalent based on lost production and health care costs– lost production may include household production

• Clearly defined and measurable

• Limited measure– not necessarily based on individual preferences– incomplete, does not include pain and suffering– price of health care may not equal costs– generally, loosely, characterized as a lower bound on willingness to pay

14

Willingness to Pay

Willingness to Pay for risk reduction ($)• Each avoided health effect converted to $ based on preferences of the

individuals affected

Well-being is expressed in a general utility function: Utility=(health, all other goods)

Willingness to pay is...• One’s own WTP for one’s own risk reduction

– WTP for others may be included under strict conditions

• Affected and constrained by income– willingness to pay includes “ability to pay”

Willingness to pay is not…• A measure of on ex post compensation experiencing health effect

– WTP is measured ex ante for risk reductions

15

Health Benefits & Methods

• Methods are based on where people appear to tradeoff risk and wealth:

– Hedonics:• Wage-risk: how much additional wages to workers require to take risky jobs?• Housing prices: extra housing price for “safer” area or higher env. quality?

– Averting Behaviors: how much do individuals pay for safety devices and safer vehicles, etc.?

– Stated Preference (Surveys): how much do individuals state they will pay for a specified risk reduction

16

Value of a Statistical Life (VSL)

• The value of mortality risk reductions is often summarized by calculating the value of a statistical life or VSL

• What is a “statistical life”?– Suppose a public policy were to reduce mortality risk by 1 in 10,000

• If 10,000 were affected by this policy then, statistically, 1 death would be avoided

– We have no idea before we implement the policy which life will be “saved.”

• What is the Value of a Statistical Life (VSL)?– Derived from the value or WTP individuals place on a small change

in risk

17

VSL Key Points

• VSL estimates do NOT capture the value of an identifiable person

• VSL estimates do NOT capture how much an individual would be willing to pay to save his own life with certainty or the life of a loved one

• Instead, VSL estimates represent (or are derived from) individual willingness to pay for a SMALL change in the probability of dying

18

Example VSL Calculations

• Suppose that each of 10,000 people were willing to pay $500 each for the 1 in 10,000 risk reduction– The value of that statistical life is the sum of the total of the individual

amounts the 10,000 people would pay for the risk reduction

• Put more generally, the value of a statistical life is calculated:– VSL = WTP* (1/risk reduction)

• In our case this would amount to…– VSL $500*(1/(1/10,000)) = $5,000,000

19

Issue: VSL and Life Expectancy

20

Morbidity (illness): ”value of statistical illness” based on WTP to reduce risks or avoid illness

We lack WTP estimates for many non-fatal illnesses• each illness is unique to some extent (severity, frequency, duration)

– requires unique research or systematic extrapolation from others

• EPA policy and practice– No set values for particular illness– Often use WTP values for similar illnesses

• Non-fatal bladder cancer use range based on WTP per statistical chronic bronchitis ($600,000) to non-fatal lymphoma ($3 million)

• Cost-of-illness methods can be difficult– Reporting is censored. Likely that many minor illnesses are never seen by

physician.

Valuing changes in morbidity risk

21

Additional Considerations (WTP)

• Equity Considerations– WTP is related to income– What if studies demonstrate the elderly have lower VSL? – recent results suggest health status has little effect on valuing mortality

risks

• Economic criticisms– sensitive to risk perceptions– does not include people’s WTP for risk reductions to other people

• Dollar terms can be compared directly to costs

• Very flexible theoretically...– incorporates broad range of health effects– can incorporate context (source of risk)

22

Issue: Timing of Exposure changes and risk reductions

The timing of risk reductions matters for the value of benefits

Generally, risk reduction like any economic good is preferred sooner rather than later (time discounting)

Also, the shorter the cessation lag:• The more cases are avoided (or lives saved) over the life of the rule or the analysis• The fewer deaths from other causes before the benefit is realized

These data are not often part of the risk assessment

23

Impact of Cessation Lags on Benefits

ABC

D

Alternative Cessation Lag “cases”

avoided

Benefits ($m)

3%

Benefits ($m)

7%

Immediate Benefits (A+B+C+D) 120 $ 429 $ 257

Exponential Decay (A+B+C) 100 $ 330 $ 176

Lagged Step Function (A+B) 60 $ 162 $ 64

30-year fixed lag (A) 30 $ 65 $ 18

24

Cost Effectiveness Analysis

• Benefits are not measured in non-monetary units

• Ranks alternatives by $ per unit, – may determine the best alternative, but cannot determine if any of the

alternatives should be done.

• For mortality risks typical “units”– Lives saved => rank by $ per life saved– Life years => rank by $ per life-year saved

• Neither of these measures accomodates non-fatal illnesses

• Cost-effectiveness cannot accommodate mortality and morbidity unless they are combined into some common measure– Quality Adjusted Life Years (QALYs) combine fatal and non-fatal

illnesses into one measure

25

QALYs for Cost-Effectiveness

Quality-Adjusted Life Years (QALYs)

• health conceptualized as having two dimensions– longevity (years)– health-related quality of life– outcome is total years weighted by quality in each year

• well-being is defined by health profile over time– Utility = U(Quality, longevity)

• wealth does not enter into this framework

26

Quality-Adjusted Life Years (QALYs)

• Assume a policy extends the baseline health profile (white)

• The gain in QALYs is shown in gray– Quality * years at that quality

• Note the risk assessment requirements: a profile of expected future health outcomes and time in each health state

27

Additional Considerations (QALYs)

• Equity considerations– interventions for young preferred to interventions for old

• Young have more life years remaining– life extensions for healthy preferred to life extensions to less-healthy

• Healthy have a higher quality than chronically ill

• Economic criticisms– assumptions are restrictive and may not reflect actual preferences– concern about quality of surveys (data)– How to deal with non-health effects (e.g., environmental) from the

policy in a cost-effectiveness framework

28

WTP QALY

Type of AnalysisBenefit-Cost

AnalysisCost-Effectiveness Analysis

Tradeoff basismoney and

risks to healthhealth and longevity

Endowment

/ Comparisonindividual wealth health profile

Social Goal Max. self-assessed welfare

Sum (individual WTP ($) values)

Max. health - weighted longevity

Sum (quality * years)

WTP & QALY: Some Conceptual Comparisons

29

Concluding Thoughts

• Economics offers tools for risk management– Risk assessment must be predictive to support economic analysis

• This kind of risk assessment is being actively pursued

– There are two widespread economic approaches to valuing changes to health and risk: benefit-cost analysis and cost-effectiveness analysis

– Benefit-cost analysis and cost-effectiveness analysis approaches use very different metrics to assess the value of risk changes

• BCA and CEA will not necessarily point to the same policy or standard.