For Internal Circulation

An Introduction to
Economic Analysis for the Health Sector

Suyash Rai
Early Child Health Practice
Social Initiatives Group, ICICI Bank
 An Introduction to Economic Analysis for the Health Sector

Scope of the note

This note, written mainly in the context of public health, introduces the theories and practices
of economic analyses for the health sector, and their importance for policymaking. Starting
with a brief discussion on resource constraints and important broad questions in health sector,
the basic concepts of various methods of economic analysis are discussed. The section follow-
ing the introduction is about the cost-of-illness analysis, which helps in quantification of the
burden of disease in monetary terms. This analysis, as we will see, has implications for inter
and intra-sectoral resource allocations decisions. After this, we discuss the economic evalua-
tion of health interventions or programmes. This analysis can aid in deciding whether an inter-
vention is economically worthy, and also for choosing between the available alternatives. It can
also help in understanding the performance of an existing intervention or programme from the
economic perspective. After this, we discuss Programme Budgeting and Marginal Analysis,
which is a framework to support decisions on priority-setting and resource allocation. In the
concluding section, we flag a few considerations for using methods of the economic analysis
or reading the results.

The greatest wealth is health. - Virgil

 Table of Contents

No. Topic PN
1 Introduction
Resource Constraints 4
Health Sector and Economic Analysis 4
Health Policy - Aspirations and Constraints 4
The Purview of Health Economics 5

2 Economic Analysis in Health

Cost-of-illness Analysis
Introduction to cost-of-illness analysis 6
Methodological Framework for estimation 7
Summary 14
Economic Evaluation for the Health sector
Introduction 15
Costing of interventions and programs 15
Types of Economic Evaluation 17
Summary 24
Programme Budgeting and Marginal Analysis 25

3 To Conclude
Using Economic Analysis 26
Summing up 27

References 29
Appendices 33
 1. Introduction

Resource Constraints
One of the primary aims of application of economic theory is to maximize the benefits
derived from available resources. This is the question of efficiency that a large part of
economics literature tries to address. The need for efficiency derives from a state of
constraints that can be understood at multiple levels. At the broadest level, it can be
argued that we live in an environment of limited resources. This implies that
consumption today is always at the cost of the potential of future generations to
consume. Also, the amount of resources readily available for consumption in a given
time period is limited, meaning that consumption for one purpose takes the resource
away from other purposes. This state of constraints at the macro level carries to specific
situations as well. This is why trade-offs are central to the economic theory. Economist
Arthur Okun aptly put it, “You can’t have your cake and eat it too is a good candidate for
the fundamental theorem of economic analysis”.

Health Policy - Aspirations and Constraints

Health policies of many countries articulate an aspiration for comprehensive quality
healthcare for all. This aspiration can be seen as a collection of expectations from the
health sector: comprehensive care, quality, and universal access. Ensuring universal ac-
cess, in itself, is a fairly challenging task. It entails ensuring timely provision of services to
every individual in the country. Comprehensiveness means ensuring every component
of a set of requirements needs to be made available. Quality is a complex idea because it
relates to the usability of the product or service for the people, making it context-specific.
There may be trade-offs, for instance, there is evidence that comprehensiveness and free
availability may come at the cost of quality1.

Prioritisation and rationing of resources are necessary to maximize the overall outcome.
Also, production of goods and services could be made more technically efficient, so that
more individuals can be treated with the same resource allocation, or there could be bet-
ter targeting, so that some people may be excluded from certain services2. Moreover, re-
allocation of public resources from other sectors could be an option in countries like In-
dia, where the public spending is clearly very low3,4. Methods of Economic Analysis can
be of help in such decisions.

Health sector and Economic Analysis

The health sector seeks to address a fundamental need for the society. This need is
particularly difficult to address in the context of the developing countries, where even
basic facilities are not available and there are too many demands on limited resources. In
such a situation, adding an economic perspective can aid the policymakers in taking
better resource allocation decisions, and improving the efficiency of existing
programmes. This can happen at different levels.

1 Aaron and Schwartz (1998)

2 Hine (1999)

3 National Health Account of India 2002. Ministry of Health and Family Welfare, India. 2005.

4 National Health Accounts of countries (www.who.int) (Accessed on October 6, 2006)

4
Firstly, there are resource constraints at the level of the economy, where economic
analysis can help make a case for appropriate allocation for health. For example, a cost-
of-illness study can bring the burden of disease in focus, thus underlining the need to
take action to prevent or cure the burden. Secondly, there is a constraint in the total
funds available for health, where the economic evaluation of interventions can help in
taking efficient resource allocation decisions. Lastly, there are resource constraints for
each programme and intervention. Here, economic analysis can help improve efficiency.

Before moving forward, let us locate this perspective in a larger framework. Most of the
health sector goals could be seen as ends in themselves, though they may lead to better
economic growth for the country. It is important for a country to set its priorities in a way
that the health goals get the status they deserve. This prioritisation is informed by under-
standings from health sciences and the idea of basic rights, and can be supported by
economic analyses. For example, based on the medical knowledge about a basic pack-
age of interventions for neonatal survival and an affirmation of a neonate’s right to sur-
vive (notwithstanding the status of parents) a government can take the decision to
provide the services. Economic analysis can then help in deciding the most efficient way
of providing the service. Economic analysis can be put to use within a larger framework
with a principle like equitable access to basic services informing broader prioritisation.

The Purview of Health Economics:

Health economics can be defined broadly as the application of the theories, concepts
and techniques of economics to the health sector5. The above diagram shows the span
of health economics.

Figure 1: The Span of Health Economics

A
B
WHAT IS HEALTH? WHAT IS WHAT INFLUENCES
DEMAND FOR HEALTH CARE HEALTH?
ITS VALUE?
Influences of A + B on Health C Occupational Hazards:
Perceived attributes of health:
Care Seeking Behaviour: Consumption Patterns:
Health status indexes: value
Barriers to Access (Price, Time, Education Income: etc.
of life:
Psychological; Formal); Agency
Utility scaling of health:
Relationship; Need.
F
MARKET
E EQUILIBRUIM
Money Prices.
MICRO-ECONOMIC
EVALUATION
D Time Prices,
Cost Effectiveness & SUPPLY OF HEALTH CARE Waiting Lists
Cost Benefit Analysis of Costs of Production; & Non-Price
Alternative Ways Alternative Production; Rationing
of improving health (eg Techniques; Input Systems as
choice of programme, Substitution; Markets Equilibrating
delivery method, for Inputs (Manpower, Equipment, Mechanisms and
treatment method, etc) Drugs, etc.) Remuneration their Differential
Methods & Incentives Effects

PLANNING, BUDGETING, & G

MONITORING MECHANISMS EVALUATION AT WHOLE SYSTEM LEVEL
H Evaluation of Effectiveness of Equity & Allocation Efficiency Criteria brought
Instruments available for Optimising to bear on E + F; Inter-regional &
the System; including the interplay International Comparisons of Performance
of Budgeting, Manpower Allocations;
Norms; Regulation, etc. and the
Incentive Structures they generate.

Source: Mills A and L Gilson. Health Economics for Developing Countries: A Survival Kit. HEFP
working paper 01/88, London School of Hygiene and Tropical Medicine, 1988

5 Mills and Gilson (1988)

5
This note touches upon issues relating to most of the fields of study depicted in the
diagram, but focus will be on those in boxes B, E, G and H. The areas of health
economics concerned with the valuation of health, economic burden of illnesses, cost
and outcomes of alternative healthcare interventions, evaluation of health systems, and
the use of such information and analysis for maximizing the achievement of the
objectives of the health sector will receive maximum attention in this note.

If you are new to economic analysis, before going to the next section it may be useful to
understand a few concepts presented in the Appendix to this note. These are the
concepts of: Economic costs, Adjusting for time factor, and marginal values.

2. Economic Analyses in Health

This note discusses three types of widely applied tools of economic analyses: 1) Cost-of-
illness study, for estimating economic burden of a disease or risk factor; a type of needs
assessment method that helps focus on areas of priority within the health sector based
on their economic burden; 2) Methods of Economic Evaluation, to compare costs and
effects of an intervention, and compare alternatives from the economic perspective; 3)
The framework of Programme Budgeting and Marginal Analysis, which can help in
prioritization and resource re-allocation for a set of programmes.

Cost-of-illness analysis

Needs assessment in the health sector is broadly of two types:6

i) Cost of illness or disease costing generating an assessment of the total economic
burden on the community of the nominated disease.
ii) Community based surveys of health care priorities, focusing on public's
perceptions about their health needs.

Both needs-assessment methods involve some data on disease/risk factor prevalence or

incidence. This data is then analysed differently. The Cost-of-illness method involves
estimating economic costs.

Introduction:

COI studies represent a descriptive economic method, wherein the estimates describe
the resources lost because of a disease. Such a study involves identifying and measuring
the direct, indirect, and/or intangible costs of a particular disease 7. Estimating the cost of
an illness can be a useful aid to policy making, and organisations such as the World Bank
and the WHO commonly use such studies8.

COI estimates can be used for determining budgetary allocations, prioritising research
funding, and justifying funding for existing and new disease programs. Though all costs
cannot be readily converted into economic terms, estimating the economic costs can
facilitate comparison among alternatives. Cost-of-illness studies also provide important
information for cost-benefit analyses, which will be discussed later in this note.

6 Segal, and Richardson (1994)

7 Byford (2000)

8 Murray and Lopez, eds (1994)

6
With a few exceptions, such studies have mainly been conducted and used in developed
countries9,10. The idea of conducting such research in a developing country like India
needs to be considered sensitively. Given the focus on economic growth in countries like
India, including an analysis of the economic costs of the problem could bolster the
argument for intervention. So, one could say that when the other rationales are not able
to get the decision, the economic rationale could strengthen the case. But this line of
argument can also lead one into a potentially undesirable territory, wherein people can
advocate for making this the central criterion for evaluating options for allocating
resources. Therefore, considering the fundamentally political nature of the enterprise of
advocacy, the idea of using economic considerations as a basis of evaluating options in
public health needs to be presented with caution, and debated widely and deeply. This
debate could be informed by a sound understanding of this analysis.

Methodological Framework for estimation:

A cost-of-illness study typically involves a few closely linked decisions regarding the
scope of the study. In this section, the questions related to these decisions are
discussed. Together they form the broad framework of a Cost-of-illness study.

What is the disease/risk factor for which the estimation is being done?
A COI study can be conducted for one or more illnesses or risk factors. The illness or risk
factor should to be defined clearly. This is important for identification of cases to be
included for estimation. For cases with multiple illnesses, it is important to decide how
the costs should be attributed. Excluding the costs directly attributed to other illnesses
may lead to an underestimation of costs, because some of these may be related to the
one being studied. Including all such costs may lead to double counting. Attributable
costs of such multiple diseases can be calculated using either attributable risk analysis
(top-down approach) or econometric analysis. These methods are discussed later, in a
section on 'estimating direct costs'.

The process of estimating costs of risk factors, such as smoking and obesity, is slightly
different from that for illnesses. Risk factors have few costs themselves, but rather cause
other conditions that may have high costs. Alderman et al (2004) estimates the cost of
Low Birth Weight (LBW) in Low-income countries. LBW is not a disease in itself, but is a
factor that can lead to increased risks of morbidity and mortality, and also a decrease in
productivity11. The LBW babies carry relatively greater risks of perinatal and neonatal
mortality and are more susceptible to developing infections. LBW baby girls are more
likely to grow up to be underweight and stunted women, who in turn have a higher
probability of delivering low birth weight babies themselves, thereby perpetuating an
intergenerational cycle of undernutrition and sub-optimal development.12 In addition,
there is suggestive evidence linking LBW to coronary heart disease and diabetes in adult
years.13 The costs due to all these should be attributed partially to LBW. Such a study is
methodologically different because the costs need to be attributed selectively and the
limitation of scientific knowledge on causality also constrains the process.

9 Rice (2000)

10 RTI-UNC Centre for Excellence in Health Promotion Economics (2006

11 RTI-UNC Centre for Excellence in Health Promotion Economics (2006)

12 Podja and Kelley, eds (2002 )

13 Barker (1998)

7
Once the disease or risk factor has been defined, the next step is proper identification of
cases in the given community or region. A process of proper identification suffers from
the limitation of relevant epidemiological data due to difficulty in case definition, under-
reporting of diseases and so on. If such data is not easily available, the researcher may
provide estimates with different prevalence rates, so that reader can use the findings
depending on the rates they find reliable.

Multiple variants of COI studies have been conducted. For instance, Moore et al (2002)
considered all the diseases in the country, classified them, and estimated all the costs
related to them for the year 199814. In another study15, costs were estimated for two
diseases, namely Atopic Asthma16 and Seasonal Allergic Rhinitis (SAR) 17. This study also
differentiated between different levels of severity of Atopic Asthma (moderate to severe).
Such methodological flexibility for detailing is possible in the COI framework.

Who are the target audience and what is the purpose of the exercise ?
If a government is commissioning a COI study for a disease with the purpose of
informing its fund allocation, it would most likely include all the social costs and not just
the productivity loss and loss due to absenteeism, which may be the only costs included
when an employer is commissioning a COI study for evaluating alternative ways of
improving productivity. Thus, the target audience and purpose of the study define the
perspective of the study. A COI study can be conducted from different perspectives,
determining what costs should be included in the estimate. For instance, Moore et al
(2002) took a societal perspective to estimate the burden of diseases in Canada, because
the purpose was to provide information for advocacy with the national policy.

Table 1: Costs Included in Cost-of-Illness Studies, by Perspective

Perspective Medical Costs Morbidity Mortality Transportation/Non- Transfer Payments
Costs Costs medical Costs
Societal All Costs All Costs All Costs All Costs -
Health Care All Costs - - - -
System
Third-party Covered Costs - Covered Costs - -
payers
Businesses Covered Costs Lost Lost - -
(self-insured) Productivity Productivity
Government Covered - - Criminal Justice Attributable to
Costs illness
Participants Out-of-pocket Lost Wages/ Lost Wages/ Out-of-pocket Amount Received
and families costs Household Household payments
Production Production
Source: Cost-of-illness Studies - A Primer (Segel, JE). 2006

Such studies can take a societal, health care system's, third-party payers', businesses',
government's, or participants and their families' perspective. As can be seen in Table 1,
societal perspective is most comprehensive and challenging. It requires data from many

14 Moore (2002)

15 Schramm (2003)

16 Atopic Asthma (or Extrinsic asthma ) refers to the onset of wheezing, cough, shortness of breath upon contact of an

allergen. (http://www.predictonline.com/azma1.htm)

17 SAR, generally known as Hay fever, is an allergic reaction to airborne substances such as pollen that get into the upper

respiratory passages and also the eyes. (http://www.netdoctor.co.uk/diseases/facts/hayfever.htm)

8
different sources, along with estimation of many indirect costs. These reasons also make
a strong case for this perspective for economic analysis in public health.

Estimates are significantly sensitive to the perspective. As an example of how this hap-
pens, consider Szucs et al (2001). They estimate the economic burden of Genital
Herpes18 in Unites States from two different perspectives, namely a societal perspective
and a Third Party Payers’ perspective. The societal perspective used a cross-sectional
survey of a sample of primary and secondary care physicians to estimate the direct med-
ical costs, whereas the third-party payer perspective used a claims database to estimate
them. The costs from societal perspective were estimated to be $984 million, while the
third-party payers’ perspective gave a figure of $283 million.

According to the authors, the difference could be explained by the influence of compli-
ance to treatment. The higher figure is obtained with data collected via questionnaire and
is likely to represent the monetary value of the amount of treatment prescribed by physi-
cians. The lower figure, on the other hand, is an estimate based on claims and represents
the minimum amount of medical care and treatment actually consumed by patients. This
difference can be expressed as the difference from what is prescribed and what is actual-
ly consumed, i.e. Compliance. A lower level of compliance means probably lower short-
term direct costs, but probably higher indirect and long-term medical costs. The paper
also states that the hypothesis of different utilization rates is also consistent with the psy-
chological aspects of Genital Herpes, which is perceived as a potential source of shame
for patients which is a plausible reason for lower levels of compliance to treatment19.

Whether the the study is incidence-based, prevalence-based, or a combination of both?

Epidemiological data being used differentiates the studies. Incidence-based studies
estimate lifetime costs. They measure the costs of an illness from onset to conclusion for
cases beginning within the period of the study, usually a year20. Incidence costs include
the lifetime medical, morbidity, and mortality costs for the incident cohort. The costs are
discounted to come to a present value.

Prevalence-based studies estimate annual costs. They measure the costs of an illness in
a given period, usually a year, regardless of the date of onset 21. These studies include all
medical care and morbidity costs for a disease within the study year. However, in many
prevalence-based studies, the mortality and permanent disability costs are calculated
differently from the other costs. Discounted mortality and permanent disability costs are
calculated for all patients who die or become permanently disabled in the study year for
that year and each year until the expected age of death22. One way of estimating the
overall costs in a region from the prevalence-based perspective is to use the National
Health Accounts framework, which is a framework for estimating the cost-of-illness in a
region for a particular disease or sets of diseases in a given year23,24.

18 Genital Herpes is a sexually transmitted disease (STD) caused by the herpes simplex viruses type 1 (HSV-1) and type 2

(HSV-2). Results of a nationally representative study show that genital herpes infection is common in the United States.

(www.cdc.gov/std/herpes/STDFact-Herpes.htm) (accessed on 25-01-2006)

19 Mindel (1996), as cited in Szucs et al (2001)

20 Segel (2006)

21 Ibid.

22 Hodgson (1983), as cited in Segel (2006)

23 PHR plus Project USAID (2004)

9
For an illness that has costs within one year, a prevalence-based or incidence-based
study would be the same because future costs would not exist. For illnesses with costs
that extend past the first year, incidence-based studies provide more information about
the costs of averting a case. One may need to use a combination of these approaches.
For instance, the Moore et al (2002) study to estimate the burden of illness in Canada for
year 1998, employed the Prevalence-based approach, except for mortality costs, for
which an incidence-based approach was used. This means that Mortality cost estimates
were based on the discounted value of current and future costs of premature deaths
occurring in 1998, rather than a prevalence-based approach wherein estimates would be
based on 1998 dollar value of premature deaths that occurred prior to 1998.

Which costs should be included in the study and how should they be estimated?
This decision is largely derived from the perspective of the study. The perspective and
resource and data availability constraints determine which of the costs get included in
the estimate. As presented in Table 1, different costs are included for different
perspectives adopted for the analysis. Firstly, the costs generated by all the cases of the
illness are identified. Traditionally, most Cost-of-illness studies identify costs that can be
classified as Direct or Indirect costs. Some studies also estimate the intangible costs.
Costs may be estimated retrospectively or prospectively, depending on reliability of
available data and resource constraints.

Direct costs: These are the resources expended for preventive or curative activities of
health care25. Basically, these include the costs borne by the health care system, com-
munity and family in directly addressing the problem. The direct costs can be further
classified into medical and non-medical costs. Direct medical costs include inpatient
care, outpatient care, nursing home care, rehabilitation care, specialists’ and other health
professionals’ care, diagnostic tests, prescription drugs and drug sundries, and medical
supplies26. The direct medical costs may also include costs on health science research,
administration, and other related health care expenditures, but these are difficult to at-
tribute to particular diseases27. Direct costs may also include labour costs, such as that of
health professionals and support staff, as well as capital costs, such as equipment, build-
ings, supplies, utilities and land28. Non-medical direct costs include transportation costs
to health care providers; relocation expenses; and costs of making changes to one’s
diet, house, car, or related items29.

Estimation of the direct costs: The direct costs can be estimated using one of the three
approaches: the top-down, the bottom-up, or the econometric approach. In the Top-
down approach, direct costs are calculated by multiplying the total health care expendit-
ures by the proportion of health care services used by the disease group. For example,
hospital costs for cancer would be the multiple of the total expenditures for hospital care
by the percentage of all hospital services used by the cancer patients. For accurate es-
timates, this approach uses aggregated data on costs along with a population-at-
tributable fraction (PAF) to calculate the costs attributable to a certain disease or risk fac-

24 PHR plus project (USAID) (2005)

25 Bernard and Anita (2002)

26 Segel (2006)

27 Bernard and Anita (2002)

28 Chan et al (1996)

29 Segel (2006)

10
tor30. The Population Attributable Factor (PAF), developed by Morganstern et al31, can be
obtained by using a formula, in which the proportion of medical care for a disease at-
tributable to another disease is measured.

The bottom-up approach estimates costs by calculating the average cost of treatment of
the illness and multiplying it by the number of cases of the illness32. Since the average
cost of treatment for an illness is seldom readily available, the bottom-up approach often
calculates the average cost of treatment by adding together the various components of
the treatment. The bottom-up approach can involve multiplying the unit cost of a particu-
lar treatment by the average amount of utilization of the treatment to get an average cost
estimate of the treatment. For example, the costs of hospital care in cancer would be cal-
culated by multiplying the average cost of a hospital stay per day by the total number of
hospitalised days attributed to the cancer patients.

The econometric or incremental approach estimates the difference in costs between a

cohort of the population with the disease and a cohort of the population without the dis-
ease33. This difference, when adjusted for other factors, can give the direct costs for the
particular disease. For instance, calculating the difference between the costs incurred by
a cohort of cancer patients and a cohort of people not suffering from cancer, and adjust-
ing this for other confounding factors could give estimate for direct costs of cancer.

Data requirement for these approaches: The econometric approach requires at least two
data sets (of those suffering from the disease and those not suffering), the top-down ap-
proach requires data on costs and relative risks for calculating the PAF, and the bottom-
up approach requires data from multiple sources for the unit cost and utilization rates. If
used properly, each of these methods can give valid estimates, but the econometric
method would usually requires lesser and more readily available data34.

Indirect costs: These are the resources forgone as the result of a health condition35.
These costs include the productivity losses caused by the problem or disease, borne by
the individual, family, society, or the employer. Non-market activities such as housekeep-
ing are sometimes omitted from analyses, or evaluated as a certain percent of the value
of market activity36. For conditions like Cancer, developmental diseases like cerebral
palsy, hearing loss, and visual impairment, epilepsy, injuries, musculoskeletal conditions
like Arthritis, and some mental disorders, indirect costs can be higher than direct costs37.

Since estimation of indirect costs requires putting a dollar value on mortality and disabili-
ty, it is a controversial arena in the cost-estimation domain. There are controversies
around the issues of ‘what to measure?’ and ‘how to measure it?’. These methods tend
to give lower estimates of indirect costs for the elderly and also for those who are less di-
rectly productive for the economy. Therefore it is important to debate whether the indi-

30 Segel (2006)

31 Morganstern et al (1980)

32 Liu (2002)

33 Segel (2006)

34 Ibid.

35 Haddix AC et al (eds) (1996), as cited in Bernard and Anita (2002)

36 Welch (1997)

37 RTI International (2006)

11
rect costs should be included at all. It may so happen that including the indirect costs
may take the attention away from the diseases of certain sections of the society.

Estimation of Indirect Costs: There are basically three methods used for estimation of in-
direct costs: the human capital method, the willingness-to-pay or contingent valuation
method, and the friction cost method. These methods are also useful for estimation of
benefits in a cost-benefit analysis, discussed later in this note.

The Human Capital Method includes only the loss of economic production due to disabil-
ity (morbidity) and premature mortality 38. Indirect costs in the human capital approach
are seen as the earnings, present and future, lost as a result of the illness. Individuals are
regarded as producing output in their lifetime that can be valued as equal to each indi-
vidual’s market earnings at that time. Therefore, the estimates for different groups earn-
ing different wages and with different employment rates are different. For estimating the
costs of permanent disability and premature mortality, the approach requires multiplying
the earnings lost at each age by the probability of living to that age. The future costs are
discounted to arrive at a present day figure.

This was one of the first methods that put a monetary value on a human life and disabil-
ity, and was subjected to criticisms for this. Some economists retort that implicit valua-
tions are placed on human lives in a whole range of decisions about allocation of re-
sources in the public sector and this approach is simply being explicit about the pro-
cess39. Another criticism is that its estimates imply that certain sections of the society,
like the elderly, and the youth are less important. It is also controversial to use existing
salaries as the basis of analysis, because there may be imperfection in labour markets af-
fecting the wage rates, which then cannot be used as perfectly reliable measure for pro-
ductivity. This is truer for a developing country like India, which also have high levels of
unemployment and under-employment, which could lead to under-estimation.

The Willingness-to-Pay (WTP) method measures the amount an individual would pay to
reduce the probability of illness or mortality40. WTP values can be estimated directly via
questionnaires asking individuals how much they are willing to pay to reduce their risk of
death or illness; by inferring from the observed behaviours of individuals in the market-
place (like examining the additional wages for jobs with high risks); by other proxy meth-
ods (like examining the demand for products that lead to greater health or safety); and
other methods41. Inferring from observed behavior is possible only in rare situations
wherein risks and the value people attach with them can be measured.

The Friction Cost method considers only the economic losses during the time it takes to
replace a worker42. The assumption is that production losses due to morbidity may not
be very high because existing labour pools and workplace structures can absorb some
of this lost productivity43. Thus, only the costs associated with the time needed to replace
a sick worker, training the new employees, and those due to differential productivity (if
the productivity of the new employee is lower than the one replaced) are included. This

38 Segel (2006)

39 Robinson (1993)

40 Ibid.

41 Rice et al (1989)

42 Segel (2006)

43 Koopmanschap et al (1995)

12
approach gives lower estimates than a Human Capital Approach, and takes a instrument-
al view of human life and capacity. In India's context, this approach is likely to give dis-
mal estimates, due to the large unused and underused labour pools.

Key criticisms of the methods: The methods for indirect costs can come up with very
different estimates because of the different assumptions underlying these methods. The
Human Capital and the Friction Cost methods look only at the productivity loss, with the
latter considering only the costs related to the replacement of the employees. Therefore,
the estimates provided by the Friction method would be lower than those provided by
the Human Capital Approach. Both these methods would generally give significantly
lower estimates for groups that are less directly active in the market.

The willingness-to-pay method puts the decision in the hands of the people, and may
give more realistic estimates because of its methodology, and takes care of the problems
with the other two approaches by looking at people’s perceptions of their own health,
but it is very difficult to use this method. This method could give lower estimates for
poorer people, because of their lower ability-to-pay. If the estimation is done through
surveys, only individual costs would be estimated, which do not cover a large part of
costs in case of diseases with high negative externalities for the society. This means that
if someone tells the willingness-to-pay to avoid a communicable disease, the person
usually conveys the indirect costs for oneself, but not the value for the society of having
one less person with a disease that can spread.

Intangible Costs: These are costs of pain, suffering, anxiety, grief and loss of leisure time,
for which a monetary value is assigned44. Intangible costs may also be seen as a subset
of indirect costs. Estimate these costs is a challenging task45. The Willingness-to-pay
approach is usually employed to estimate these costs46. Another way of estimating is to
use the domestic wage rate as a shadow price for the lost opportunity of domestic
activities47. In many cases, non-wage and work time may overlap, and difficulties may
arise in separating these elements when illness has implications for both. For example, a
patient attending a hospital outpatient session in the afternoon may make up his lost
employment by staying extra time on return to work, in which case the cost of his
attendance is his leisure time. These and other such issues make it a complicated
exercise to estimate the intangible costs of an illness.

Measuring the costs - Marginal, average and joint costs: Most decisions in health care
are not binary i.e. they are not concerned with whether or not a service should be pro-
vided, but with how much of the service should be provided, that is, should existing lev-
els of provision be expanded, contracted or left at the same level?48 Consider questions
like: Where should maternity care services be made available? Should the existing pub-
licly funded interventions around childcare be limited to the poor or should they be al-
lowed to remain as they are? Such decisions do not get much help from average esti-
mates but need estimate for marginal changes. Marginal costs are the costs for every ad-
ditional change, while the average cost is total costs divided by the number of units of
outcome from the process. For example, while estimating the costs of hospitalization
care, the average cost would be the total cost of hospitalization divided by the number of
44 Choi et al (1997)

45 Posnett and Jan (1996)

46 Ibid.

47 Kernick (2000)

48 Robinson (1993)

13
patients. The marginal cost is the cost of each additional patient taken for inpatient care
at the given point of time. Table 2 illustrates the difference. In the short run there is often
an important difference between the marginal costs of an activity and its average cost49.

Table 2: Average and Marginal Costs

Number of patients Total Cost (in Rs.) Average Cost (in Rs.) Marginal Cost (in Rs.)

10 2000 200 -
20 2400 120 40
30 2800 93 40
40 3000 75 20
50 3200 64 20

A bottom-up approach is more appropriate for estimating marginal costs, because of its
use of primary patient-specific data.

An area of difficulty in cost estimation can be of joint costs50. There are processes that
lead to more than one outputs. One example is of tests like blood tests and urine tests
that can lead to multiple diagnoses. One of the ways used for allocating the costs in such
cases is to allocate the costs on the basis of number of units of utilization, like taking the
number of tests in a laboratory to allocate the costs of laboratory. Another way of allocat-
ing these costs can be to equally allocate to all the diagnosed diseases.

Summary

A Cost-of-illness study is an economic method for needs assessment in heath, which

gives the estimate for the economic burden of disease or risk factor for a community/
region. The first step is to define and identify cases of the disease or risk factor clearly.
After this, one has to decide about the target audience and purpose perspective, from
which the perspective of the study is decided. The perspective, in turn, determines which
costs should be included. The costs included may be direct, indirect and/or intangible,
based on a prevalence or incidence-based approach. There are potential debates and
controversies for each of the decisions involved in such a study. Therefore it is useful to
provide estimates using as many combinations of different variables as possible.

A cost-of-illness study can help in prioritising among diseases and risk factors that need
intervention, but it cannot help compare costs and effects of an intervention, neither can
they help compare alternative interventions. To take intervention decisions, we need
methods that help in a more complete understanding of opportunity costs in a situation,
determine economic viability of an intervention, and help compare alternative
interventions for solving a problem, based on the relationship between resource usages
and health effects. Economic Evaluation Methods can complement cost-of-illness studies
by comparing the costs and health effects of alternative interventions.

49Ibid.

50Ibid.

14
Economic Evaluation for Health Sector

Introduction

The Cost-of-illness study discussed earlier does not help in identification, assessment, or
comparison of health interventions that may affect the burden of disease. This is where
the economic evaluations come in. Evaluation of health care interventions/programmes
may be subdivided into evaluation of efficacy, effectiveness, availability, accessibility and
efficiency. Evaluation of efficiency is more commonly known as economic evaluation51.
One should consider the following alongside the question of efficiency52:
- Can the health intervention work (the efficacy of the intervention)?
- Does the intervention work (effectiveness)?
- Will it be reaching those who need it (availability and accessibility of the service)?

In the context of the health sector, using economic evaluation to maximise efficiency is
useful when these considerations have been addressed satisfactorily. Achieving an
optimal allocation of resources, one that maximizes well being, requires attention to the
three economic questions53:
i) What to produce: known as `Allocative Efficiency' and concerned with the
optimal mix of goods and services;
ii) How to produce: known as `Technical (or production) Efficiency' and concerned
with the least cost combination of resource inputs for the production of
nominated goods or services; and
iii) To whom should goods and services be distributed; the question of equity.

An Economic Evaluation compares costs and outcomes of the programs, thus providing
an important input for choosing between multiple programs. All the economic evaluation
methods involve systematic identification, measurement, and, wherever appropriate,
valuation of all the relevant costs and consequences of the options under review. The
following diagrammatic representation illustrates what economic evaluation involves.

Figure 2: Economic Evaluation

Economic Evaluation

Costs Benefits
Health
Healthcare inputs Intervention or Health Outcomes
program

Costing of interventions and programs:

The costs of interventions and programs can be direct or indirect. In such estimations,
direct costs represent the resources consumed by the intervention and associated

51 Cunningham (2001)

52Drummond and Davies (1991)

53 Segal and Richardson (1994)

15
events54. For example, direct costs associated with primary care include doctor’s time,
practice nurse costs, drugs, and capital costs arising from equipment and buildings.
Indirect costs may be tangible, i.e. productivity losses or inputs from caregivers, or
intangible, i.e. loss of leisure time, costs of pain, suffering, uncertainty or death 55.
Methods for estimating costs are similar to those discussed in the section on COI
studies.

As in the cost-of-illness studies discussed earlier, the estimation of costs of interventions

also significantly depends on the perspective of the study. The perspective depends on
the target audience and purpose of the study. The broadest perspective one can take is
the societal perspective. A case can been made for taking a societal perspective, particu-
larly for public health programs and interventions, but the range of resource effects that
are potentially relevant for the societal perspective is enormous56.

Procedure for costing: Three stages can be distinguished in the costing process57: identi-
fication, measurement, and valuation of costs. Identification involves listing the likely re-
source effects of the intervention as comprehensively as possible so that frame of the
study can be finalised i.e. which effects might reasonably be excluded. This step involves
formation of a decision problem (including the objectives of costing, the perspective of
costing, and the time horizon), the description of particular intervention or program (cost
object), as well as the identification of resources used to deliver the service 58.

The second stage, i.e. Measurement, refers to measuring the resource changes (costs)
included in the study. At this stage, the measurement of resource utilization is done in
terms of natural units. For example, hospital beds are counted as the number of hospital
beds and not as their costs in monetary terms, which are estimated in the next stage.

The third stage, i.e. Valuation, involves attaching monetary value to resource use59. One
way of doing this is to use prices as a proxy for costs 60. If prices are known, and we as-
sume that they reflect costs, then they can be multiplied by corresponding units of re-
source use to yield total costs. For example if x is the number of hours given by a doctor,
and y is the per hour fee for consultancy, then x multiplied into y would give the total
price, which can be used as a proxy for costs. Two problems complicate this relatively
simple process: prices often do not exist for the relevant changes, and available prices
may not reflect the societal value of resources. Economic theory suggests that prices re-
flect resource values only under conditions of perfectly competitive markets, a situation
appearing rarely in the economy and hardly in health care. Thus, other strategies for es-
timation may be recommended.

Strategies for costing: Two broad strategies61 are- micro costing and gross costing. Mi-
cro costing involves detailed primary analysis of the changes in resource use due to the
intervention. This means the researcher identifies, measures and values each of the costs
54 Kernick (2000)

55 Ibid.

56 Byford and Raftery (1998)

57Raftery (2000)

58 Mogyorosy and Smith (2005)

59 Ibid.

60 Raftery (2000)

61 Ibid.

16
incurred for the intervention, and adds these costs to arrive at the total cost. This
strategy follows a bottom up approach to estimating costs, discussed earlier in this note.

Gross (or top down) costing allocates total costs or budget in the context of a facility or a
larger program to specific interventions or services62. Here, the approach to estimation is
a “top-down” one, involving attribution of total costs to specific interventions or services.
Conceptually, it is similar to the top-down approach discussed earlier in the note.

The micro-costing approach would give the actual marginal cost of the intervention,
while the gross costing approach gives average costs. In most contexts, marginal costs
may be more relevant than average costs. A micro-costing approach is more likely than a
gross-costing approach to give a reliable estimate that can be used for taking decisions.
Some studies use a mix of the two, micro costing for some of the costs, and gross cost-
ing for others63. Costing can be done retrospectively (using past data) or prospectively
(using data as it is recorded) as well. Appropriate adjustments for time should be done.

Example of a costing exercise: Though a costing exercise is useful when it is accompan-

ied by an estimation of related outcomes, it can by itself can be useful for pinpointing
flaws in the current processes and practices. We take the example of Borghi et al (2002),
estimating the costs of publicly provided maternity services in a city of Argentina64. The
study estimated provider costs of antenatal care, a normal delivery, and a caesarean sec-
tion. The exercise was done retrospectively. The study found the cost for caesarean sec-
tion ($525.27) to be five times that for a normal delivery ($105.61). The average costs for
an Antenatal visit were less than one-third of those for a normal delivery ($31.10).

It was found that a normal delivery costs less at the general hospital and a caesarean
section costs less at the maternity hospital. For antenatal care, the provider costs were
lower at the health centre than at the hospital. For the women, the cost of an antenatal
visit was around $4.7, most of which was due to indirect costs due to travel and waiting
time. This was because most of the formal costs are subsidized. Please refer the Ap-
pendix for details of identification, measuring and valuation for this study.

A number of recommendations were derived from these findings. It was concluded that
efficiency could increase if the antenatal visits at primary level could be promoted and di-
verted away from higher-level facilities. This could also help the women by cutting their
indirect costs by reducing travel and waiting time. It was also recommended that encour-
aging normal deliveries at general hospitals and complicated deliveries at specialized
maternity hospitals could increase efficiency.

Though the methods available for costing interventions/programs are common for any
economic evaluation, there are four types of economic evaluation, differentiated by how
they look at the outcomes.

Types of Economic Evaluation

The methods of economic evaluation are: Cost-minimization Analysis (CMA), Cost-

effectiveness Analysis (CEA), Cost-benefit Analysis (CBA), Cost-utility Analysis (CUA).
Though all these can support decisions about resource allocation, they differ in their

62 Ibid.

63 Raftery (2000)

64 Borghi (2003)

17
methodologies. The benefits are estimated differently, with the cost-minimization, as we
will see, assuming the benefits to be equal for all the interventions under focus.

Cost-minimization Analysis:

Cost-Minimization Analysis is a type of analysis in which the outcomes of the interven-

tions or programs being compared are assumed equal, thereby resulting in an assess-
ment based solely on comparative costs65. It is an appropriate evaluation method to use
when the case for an intervention has been established and the programs or interven-
tions under consideration are expected to have the same, or similar, outcomes66.

The assumption of equal outcomes can be risky, as such assumptions rarely hold in
practice67. This has limited the application of this approach considerably. This method is
also inappropriate for separate and sequential hypothesis tests on differences in effects
and costs to determine whether incremental cost-effectiveness should be estimated68.

In spite of these limitations, there are a few examples of its use. Nathwani et al (2003) did
a retrospective audit of managing 55 treatment episodes of bone and joint infections
with teicoplanin69 delivered in the outpatient or home setting and found the mean cost of
care per episode of infection to be less in ambulatory setting (£1749.15), than in in-pa-
tient setting (£11400) or in the hypothetical situation of treatment with oral linezolid in the
home setting (£2546). Vinodkumar and Jacob (2004) identified the areas of increased ex-
penditure on drugs and disposables used during anesthetic practice in the operating the-
aters and then tried to minimize the use of expensive drugs and disposables without
compromising on the quality of anesthetic care, thus bringing down mean cost per case.
Another use CMA could be to determine the optimal level of provision of a service. Khan
et al (2001) conducted such an exercise to plan the geographic distribution of health fa-
cilities in Bangladesh70, particularly to determine the optimal distribution of Emergency
Obstetric Care (EOC) facilities to minimize the average social cost per woman.

Cost-Effectiveness Analysis

Like a cost-minimization analysis, a Cost-effectiveness analysis also takes the worthiness

of the health goal as a given, and helps in finding the best way of achieving it. For a cost
effectiveness analysis, the outcomes of the alternative strategies are measured in natural
units, such as lives saved, years of life saved, and reduction in prevalence, and should be
expressed in a single dimension or unit71. The future health effects are usually discount-
ed using the same rate as for discounting future costs, but there is an argument advocat-
ing lower rate for discounting health effects, taking into account the growth in the future

65 Shiell, A, et al (2002)

66 Robinson (1993)

67 Robinson (1993)

68 Briggs and O’Brien (2001)

69 Teicoplanin belongs to a group of antibiotics called glycopeptides. It is used to treat serious infections of the heart and

blood. (www.tisali.co.uk/lifestyle/healthfitness/health_advice/netdoctor/archive/100003919.html) Accessed: Feb 1, 2007

70 Khan et al (2001)

71Robinson (1993)

18
value of health effects72. CEA considers both costs and effects, giving scope for a more
expensive intervention to get considered, if it produces better effects.

If effects of alternative interventions are same, choice is relatively easy. One would
choose the least expensive option. Similarly if the alternatives cost the same, we would
choose the one that has the maximum effect, ceteris paribus. But, in situations where al-
ternatives produce different levels of outcome and require different levels of investment,
we need to to consider ratios of costs and effects, that depict the cost per unit of out-
come obtained, in comparing one treatment option to another73. For example, a home-
based management of severe malnutrition gives lower results than a facility-based one,
and with lower costs. Cost-effectiveness ratio (CER) can be average or incremental.

The generic formulae for calculating these cost-effectiveness ratios are:

Average CER = (costs)/(health effects produced)
Incremental CER=(Cost difference between A & B)/(Difference in health effects from A&B)

Whether an average or incremental cost-effectiveness ratio is used depends on the rela-

tionship between alternatives in question. There are independent interventions, where
costs and effects of one intervention are not affected by the introduction of the other,
and then there are mutually exclusive interventions, where implementing one interven-
tion means that another cannot be implemented, or where the implementation of one in-
tervention affects the costs and effects of other interventions. The independent interven-
tions are usually those that serve different sets of people. Usually, for comparing inde-
pendent interventions, average cost-effectiveness ratios are used, and for mutually ex-
clusive interventions incremental cost-effectiveness ratios are more appropriate 74. The
average CERs help rank the independent alternatives, and then an optimal mix of inter-
ventions within the available budget can be determined. Consider the following table

Independent Interventions
Intervention Cost (Rs.) Effect (life years saved) Average CER (Rs./life year saved)
A 60000 15 4000
B 40000 8 5000
C 120000 20 6000
In the above table, there are three independent interventions, each with a different pa-
tient group. Holding everything else constant, upto a budget of Rs. 60000, it would be
best to spend only on intervention A, then on B, followed by C, as budget increases.

Mutually Exclusive Interventions

Intervention Cost (Rs.) Effect (life years saved) Incremental Incremental Incremental
Cost Effect CER
P 100000 10 100000 10 10000
Q 120000 15 20000 5 4000
R 90000 18 -30000 3 -10000
S 140000 20 50000 2 25000
T 130000 22 -10000 2 -5000

72Gravelle and Smith (2000)

73 Shiell (2002)

74 Phillips and Thompson (2007) (www.evidence-based-medicine.co.uk)

19
For a situation with mutually exclusive interventions, which usually affect the same con-
dition, firstly the interventions have to be ranked in the ascending order of effect. After
this, the incremental ratios have to be computed. The negative ratios for R and T show
that they produce greater effects at lower cost than their preceding interventions Q and
S. Now, interventions that are more expensive and less effective are excluded. In this
case, Q and S are such interventions. After this the ratios are computed again for the
residual alternatives. From the resulting table, the alternatives with higher incremental ra-
tio than the next alternative should be excluded and this process should be continued till
we have a table of alternatives with the incremental ratios in an ascending order. Choice
from these remaining alternatives can be made depending on the budget.

Usually, a cost-effectiveness analysis considers only one outcome, but sometimes more
than one outcome may be relevant. In such a context, a variant of cost-effectiveness
analysis called cost-consequence analysis is applied. In this method all the important
outcomes are presented with relevant cost effectiveness ratios and the reader is left to
judge the relative importance of the outcomes75.

The validity of a cost-effectiveness analysis depends significantly on the quality of the ef-
fectiveness trial, because the data on the effects of intervention comes from that. Some-
times it may be difficult to get good evidence relating health inputs to outputs, particular-
ly for new technologies and interventions, which are commonly the focus of economic
evaluation. Though it is possible and ideal to build cost effectiveness analysis in a trial,
many studies depend on other existing trials of effectiveness, because including the
costing component in trials is considered to be costly and time-consuming76. 'Bias' in the
study can be another challenge to its validity. Doubts have been raised about the validity
of many existing cost-effectiveness studies. Bell et al (2006) found that most published
analyses report favourable incremental cost effectiveness ratios. Studies funded by in-
dustry were found to be more likely to report favourable ratios.

Cost-effectiveness analysis is one of the most widely used methods of economic evalua-
tion, with many examples of its use. Wandwalo et al (2005) compared the cost-effective-
ness of two alternative ways of treatment of tuberculosis, namely health facility based
directly observed treatment (DOT) by health personnel and community based directly
observed treatment by treatment supervisors, and found that the former costs more than
the latter, with costs falling more for patients than for health services. Such analysis has
significant public health implication, particularly where the resources are over-stretched.
The analysis has also been used to identify sources of inefficiency. For instance, Vennin
et al (2000) conducted a trial with 20 general practices in England and Wales to compare
the cost effectiveness of general practitioners and nurse practitioners as first point of
contact in primary care, and found that if nurse practitioners maintained the benefits
while reducing their return consultation rate or shortening consultation times, they could
be more cost effective than General Practitioners.

CEA analysis can aid in sector-wide choices. Edjer et al (2005) identify cost-effective
strategies for child health in developing countries, considering selected child health inter-
ventions, namely case management of pneumonia, oral rehydration therapy, supplemen-
tation or fortification of staple foods with Vit A or zinc, provision of supplementary food
with nutrition counseling, and measles immunization. Similarly, Adam et al (2005) evalu-
ated interventions for maternal and neonatal health in parts of Africa.

75 Goodacre and McCabe (2002)

76 Robinson (1993)

20
The two types of economic evaluation discussed till now pre-suppose the worthiness of
the health goals, and help in identifying the most efficient way of achieving them. Cost-
Utility and Cost-benefit analysis go a step backwards and address the question of worthi-
ness of the goal. Also, many a times it is not possible to do a cost-effectiveness analysis
because the outcomes of interventions competing for resources are in different units. In
such situations, cost-benefit or cost-utility analysis can be useful.

Cost-benefit analysis:

Cost-benefit analysis (CBA) values both costs and benefits in monetary terms, and
compares them, assessing whether the intervention is desirable through the use of a
decision criteria (e.g. if the benefit cost ratio (benefits divided by costs) is greater than
one, the intervention is worthwhile)77. CBA doesn't take the worthiness of the goal as a
given. The outcome is converted into a monetary value, which is then compared with the
costs in monetary terms to arrive at a ratio, which suggests the intervention's worthiness.

Costing of interventions is done in the same way as in other methods. Conversion of ef-
fects into monetary values is unique to this type of evaluation. The cost-benefit ratio can
be used for deciding about the economic worthiness of an intervention as well as for
comparing interventions. Placing monetary value on effects is also controversial because
it entails putting dollar value on human life and morbidity. The methods to quantify the
losses due to illness and premature mortality in a cost-of-illness study, can also be used
value a reduction in morbidity and mortality from an intervention. Discounting of future
benefits is done using the same rate as that for discounting future costs78.

Using these methods in a country like India can lead to under-estimation of benefits,
largely because of the low incomes and high levels of unemployment and under-employ-
ment. It is not easy to compare such studies internationally, as results will tend to get
skewed due to many factors affecting the economy of the respective countries.

Doing a cost-benefit analysis from one perspective and comparing the estimates with the
estimates (and decisions) from another perspective can help in presenting the problem
and alternatives from a fresh perspective. Cost-benefit analysis by Poulos et al (2004) il-
lustrated why typhoid vaccination programmes may appear to be unattractive to public-
health officials who adopt a public budgetary perspective. They found that under many
plausible sets of assumptions, public-sector expenditure on typhoid vaccination does not
yield comparable public sector cost savings. The paper concludes that if public-health of-
ficials adopt a societal perspective on the economic benefits of vaccination, there are
many situations in which different vaccination programmes will make economic sense.-
Cost-benefit analysis can be used to determine the economic viability of the interven-
tions. For instance, Wang et al (2003) estimated the net benefit or cost of implementing
electronic medical record systems in primary care. Levin (1986) did a similar analysis for
nutritional programmes for anaemia reduction79.

Cost-utility analysis:

Cost-utility analysis is a form of economic evaluation in which the outcomes of alterna-

tive procedures or programmes are expressed in terms of a single, "utility based" unit of
77 Mills and Gilson (1988)

78 Gravelle and Smith (2000)

79 Levin (1986)

21
measurement80. The costs of interventions for this method are estimated in the same
way as that for the other methods.

Health Utility: Health Utility is a measure of strength of preference people have for partic-
ular health states81. A year with full health from the point of view of a particular aspect of
health status is assigned a value of 1 while a state that is considered equivalent to death
is assigned a value of zero. Health states that lie somewhere between these two points
are assigned utility values that are somewhere between zero and one. Some states are
considered to be worse than death, and are given utility scores less than zero. Health util-
ities are used to attach weights to improvements in life expectancy. Five techniques have
been used which purport to measure82: the use of category rating or a rating scale (RS),
standard gamble (SG), time trade off (TTO), equivalence techniques (ET) and magnitude
estimation (ME). There are also standard descriptive systems like EuroQoL83 that can be
used to determine the weight associated with a particular health state.

These techniques involve presenting a health state description to people and eliciting
their preferences for the health state relative to some reference states, usually full health
and death. The standard gamble approach is the classic method of measuring prefer-
ences in economics, first presented by von Neumann and Morgenstern84. In this method
people are asked to choose between the certainty of the specified health state for a given
period of time or a gamble that involves a probability (p) of restoration to full health and
a complementary probability (1-p) of immediate death85. The value of p is changed until
the respondent regards the two options as equivalent to each other. The utility of the
specified health state is then given by p.

In Time trade off method, the respondent faces a choice between living for a given peri-
od of time (t) in the specified health state or a shorter period of time (x) in full health86.
The duration in full health is altered until the respondent regards the two options as
equivalent to each other. The value of the health state is then given by (x/t).

Quality Adjusted Life Years (QALYs): Quality Adjusted Life Years (QALY), a summary
measure of health gain combining (changes in) life expectancy and quality of life, is one
of main utility-based measures. QALYs are measured as expected number of years of life
multiplied into a health utility weight, which quantifies that aspect of the quality of life
upon which decisions should be made87, and then adjusting to get the present value.

Suppose an individual has just one health state each year and the state is known with
certainty in advance, and the utility scores for these states are known. These states can
be denoted by Qt (where t = 1,2,…..T). T is the expected number of life-years left. The
person’s QALY score is given by:

80 Robinson (1993)

81 Torrance (1986)

82 Richardson (1990)

83 Williams (1995)

84 Von Neumann and Morgenstern (1953)

85 Shiell et al (2002)

86 Ibid.

87 Richardson (1990)

22
QALY = Σt=1T[1/(1+i)t-1] X u(Qt), where u(Qt) is the utility associated with being in state Qt
for one year and i is the rate of discount.

If a state of living with a disease is assigned a health utility of 0.6, and expected life years
are 10. The QALY score would be equivalent to 10X0.6 = 6 QALYs. Thus any measure
that prevents one from entering such a state of disability would be saving 10 - 6 = 4
QALYs. For sake of understanding, we have not considered discounting in this example.

Cost-Utility Ratios: If there are two alternative interventions, one of which produces less-
er QALYs but at more or the same cost as that of the other, the choice becomes simple.
One would always choose the intervention with higher production of QALYs. The choice
becomes a little difficult when a more expensive intervention also produces more
QALYs. Comparison between such alternative interventions is done by using cost-utility
ratios. A cost-utility ratio is given by the difference in costs of the two interventions di-
vided by the difference in the number of QALYs produced by the two interventions. This
ratio gives the incremental cost of producing one extra year of perfect health (QALY) by
the intervention producing more QALYs.

For example, suppose intervention A produces 10 QALYs for Rs. 400000, and interven-
tion B produces 14 QALYs for Rs. 700000. The cost per QALY produced by intervention
A is Rs, 40000, while that for intervention B is Rs. 50000. The cost-utility ratio for compar-
ing the two interventions is given by: (700000-400000)/(14-10) = 300000/4 = Rs.75000,
which is the cost per extra QALY produced by interventions B. The choice is based on
available budget.

To determine the worthiness of an intervention, the policymakers need to, based on their
priorities and resource-constraints, decide the threshold beyond which the investment in
the intervention can be considered. As of January 2005, a figure of £30,000 per QALY
was the normal British threshold value88. Thus, any health intervention which has an
incremental cost of more than £30,000 per additional QALY gained would normally be
rejected, while the others could be given a consideration.

A number of health status measures have been developed in the recent years, as a re-
sponse to a demand for a measure that accounts for quality of life. Many of these meas-
ures have not been able to answer the specific question: whether or not they indicate a
treatment, which should be chosen in preference to some other treatment for the same
or for some other disease89. This was because most of these measures lacked interval
properties. For a measure with interval property, if health intervention A improves pa-
tients' health by 10 points on a scale and intervention B by 5 points, then intervention A
can be said to be producing twice as much improvement as B90. QALY as a measure of
health status has interval properties, making it easier to compare the magnitude of differ-
ence in effects. Another important advantage of this approach is that the outcomes of
health care interventions are measured in units that combine quality and quantity of life,
and can aid in comparisons between different interventions and health problems.

There are many criticisms of the QALY as a measure. There is an ambiguity in the
concept of 'utility' itself. One of the supposed strengths of utility measures is that their

88 Wikipedia (http://en.wikipedia.org/wiki/Cost-utility_analysis)

89 Richardson (1990)

90 To Read more about interval properties, please refer any good statistics textbook.

23
valuation is based on individual preferences91. Therefore, one of the strongest criticisms
was aimed at this strength by asserting that the QALYs misrepresent consumer prefer-
ences and thus, lead to decisions and policies that do not reflect people’s preferences92.
Economists like Culyer and Wagstaff (1992) have argued back by acknowledging that
QALYs may misrepresent preferences but there is no evidence that they actually do so93.

McGregor (2003) has identified some key points to look for in a cost-utility analysis 94.
These are: The QALY should be meaningful (its significance understandable by the user),
valid (measuring what it is intended to measure), reliable (repeatable by the same or dif-
ferent individuals) and relevant (applicable to the population affected by the policy in
question). To understand the details of these conditions with an example, please see Mc-
Gregor (CMAJ, 2003). Some people have argued for adoption of other measures for a
Cost-Utility Analysis, like the Health Year Equivalents (HYEs)95.

Most examples of CUA are from developed countries. Forbes et al (1999) evaluated the
cost utility of interferon beta-1b96 in secondary progressive multiple sclerosis. They found
that the cost per QALY gained is high because of the high drug cost and modest clinical
effect and concluded that resources could be used more efficiently elsewhere. A criticism
of this paper by Ellis (1999) pointed out some problems in the methodology used for the
paper. The criticisms centred around the fact that the study uses a single aspect of disab-
ility (wheelchair dependence) and then extrapolates QALYs to which a price tag is at-
tached, completely ignoring the other problems associated with the disease. Another cri-
ticism by Ellis (1999) contests the underlying assumption behind QALYs that badness of
a disability is a fixed quantity. Many healthy people might say they would prefer to be
dead rather than live with a significant disability, but if you ask disabled people they gen-
erally prefer to be alive. The badness of a disability depends on one's perspective and is
not fixed. These criticisms can be extended to other such studies also.

In situations where, given the advantages and disadvantages of different interventions or

procedures, it is difficult to choose any one of them, Cost-utility analysis can, by giving
rank order on the basis of effectiveness, quality of life and economic considerations, help
in choosing one of the interventions. For instance, Leung et al (1999) compare Paclitaxel,
docetaxel, and vinorelbine, which are drugs approved for chemotherapy in patients with
advanced breast cancer resistant to anthracyclines97.

Summary:

Economic evaluation can help in determining the economic worthiness of an interven-

tion, and in comparing interventions from an economic point of view. There are four

91 Torgerson and Raftery (1999)

92 Gafni (1989)

93 Culyer and Wagstaff (1992)

94 McGregor (2003)

95 Richardson (1990)

96 Interferon beta-1 b is a highly purified protein that has 165 amino acids. From the Internet Drug Index.

(http://www.rxlist.com/cgi/generic/interferon_beta.htm) (Accessed on January, 20, 2007)

97 Anthracycline is a member of a family of chemotherapy drugs that are also antibiotics. The anthracyclines act to

prevent cell division by disrupting the structure of the DNA and terminate its function. (www.medterms.com) (Accessed

on: Jan 6, 2007)

24
types of economic evaluation, each with a different method of outcome evaluation. The
following table summarizes these types of economic evaluation:

Types of Evaluation Costs Outcomes

Cost-minimisation Monetary Identical
Cost-Effectiveness Monetary Same type (Natural Units)
Cost-Benefit Monetary Monetary
Cost-Utility Monetary QALYs

These methods are also different in the breadth of their analysis. CMA and CEA tacitly as-
sume that the health objectives, which the interventions/programs serve, are worthwhile.
CUA permits choice between a much wider range of interventions but still ultimately as-
sumes that at some cut-off point of cost per QALY, a programme is worthwhile. CBA in
theory permits assessment of whether the health objectives are worth achieving in the
first place98. In other words, cost-benefit and cost-utility analysis both address the issue
of outcome valuation and, therefore, shed more light on whether certain treatments are
worthwhile, while on the other hand, cost-minimization and cost-effectiveness assume
that the intervention is worthwhile99.

Each method of evaluation has its own set of assumptions about outcomes and their re-
lations with costs. There are advantages and disadvantages of all these methods, based
mainly on their underlying assumption.

Programme Budgeting and Marginal Analysis

Programme Budgeting and Marginal Analysis (PBMA) is an economic framework to as-

sist priority setting and resource allocation, with an aim to maximise benefit and minim-
ize opportunity costs100. The programme budget is a map of the current use of resources.
Through marginal analysis, changes in the amount or the mix of services provided for a
given population are identified. Conceptually, this approach is a lot like economic evalu-
ation, but is more pragmatic and is applicable at various levels of decision-making 101. For
instance, PBMA can be applied in individual programs of care, across a set of programs
within the same general area, or more broadly, across areas. The approach can also be
used for considering funding decisions for new technologies or interventions.

The main idea is to get opportunity cost and marginal analysis to inform the decision
making process. Marginal analysis examines the incremental costs and benefits of shift-
ing resources from one area to another, i.e. Implications of a decision. Marginal analysis
considers unit changes in production of an intervention determines the best mix of ser-
vices by examining the relative costs and benefits of the various options, at the margin.

There are basically three budgetary positions wherein this framework may be useful 102:
Firstly, whenever there is a proposal for increasing budgetary outlay, there is a decision
on how best the additional resources should be spent. Secondly, if there is a budget de-
crease, one would want to take resources from areas, which are producing the least be-

98 Mills and Gilson (1988)

99 Cunningham (2001)

100 Shiell (2002)

101 Mitton and Donaldson (2004)

102 Ibid.

25
nefit. Lastly, if the budget is neither increasing nor decreasing, the question remains as to
whether resources should be re-allocated so as to improve benefits to target population.

Mitton and Donaldson (2004) list a broad set of steps for a PBMA priority-setting process.
The approach involves i) determining the aim and scope of priority-setting exercise, ii)
compiling a budget, iii) determining relevant decision making criteria, iv) identifying op-
tions in terms of areas for service growth, for resource release through increasing effi-
ciency of interventions, for resource release though scaling back some services, iv) re-
commending changes in terms of funding growth areas with new resources, moving re-
sources from areas with inefficiency to areas of service growth, and taking trade-off de-
cisions to move resources from scaling back services to areas for service growth. The fi-
nal decisions should be preceded by validity checks with additional stakeholders.

So basically the process involves choosing a set of programmes, identifying the places
where resources are currently being used within those programmes, identifying places
for improvements, preparing a priority list by comparing the incremental costs and bene-
fits, and deciding about the changes. In other words, it involves tweaking around with
the existing resource allocation to move closer to an optimal state.

Carter et al tested the appropriateness of the PBMA framework for assisting cancer con-
trol planning. Eight options for change, involving both increments (additional expendi-
ture) and decrements (reduced expenditure) were evaluated and ranked according to
their cost per Disability Adjusted Life Years (DALY)103 results. All increment options were
considered suitable for inclusion within the National Cancer Strategy of Australia. Of the
two decrement options evaluated, one was considered suitable for adoption. The Re-
searchers cautioned that though there are good reasons to support the credentials of op-
tions evaluated in the PBMA trial, this should not be overplayed. There may well be other
potentially cost effective interventions available that were not evaluated as part of the
PBMA trial. Thus, it is important to shortlist the options carefully.

The researchers concluded that while there were aspects of the PBMA methods and pro-
cess that could be criticized and improved upon, the PBMA approach marks a progress
in the quality of information available for decision-making. The information produced and
the process by which this information was assembled were viewed in a positive light.
More specifically, the use of an evidence-based approach facilitated by a suitably quali-
fied research team assembling information was strongly supported by the researchers.

3. To Conclude
Using Economic Analysis

Resource Allocation is a contested turf. The contest is not just between different
alternatives for the same group, but also between different groups advocating for the
policies and interventions that benefit them. If the question was only about choosing the
best alternative for a given homogenous population, the answer would have been easy
to arrive at. In reality, there are people with different levels of health and socio-economic
statuses. Most policies would tend to affect them differently. This introduces a
complexity in the situation, requiring the decision to be more broad-based.

103 DALYs for a disease are the sum of the years of life lost due to premature mortality (YLL) in the population and the

years lost due to disability (YLD) for incident cases of the health condition. (www.who.int/healthinfo/boddaly/en/index)

(Retrieved on: December 26, 2006)

26
People have questioned the methods of economic evaluation for not representing the
distributional aspects of outcomes.104 It is crucial to give importance to the outcomes and
costs according to the profile of beneficiaries, and thus including the equity aspect in the
analysis. For example, imagine there are two alternative childcare programs, both with
the same level of overall outcome for the population, but with slightly different
beneficiary sets. The benefits from one of the programs are skewed in favour of the
poorest, while those from the other program in favour of the richest. Preferring the
former may be more advisable for maximizing the overall welfare in the society.

Averages can be misleading. Therefore, one needs to disaggregate the data on the basis
of different parameters. One of the methodological solutions could be to attach weights
to health outcomes for specific dimensions (e.g. age, socio-economic condition)105. A
Cost-of-illness study, which estimates the burden of disease for a region, needs to be
applied in a way that one can estimate the burden for different socio-economic and
demographic groups. Similar disaggregation could be done for economic evaluation
studies. The costs and effects may vary for different groups because of many reasons,
including some demand-side factors106,, which should be mapped. Also, given the
possibility of multiple views about some of the variables considered for deriving the
estimation, it is advisable to include sensitivity analysis107 in such studies.

These are complex methods with many assumptions, each of which affects the estimates
of costs or benefits, or can skew the results for or against any group. Understanding the
assumptions before using the results is crucial. Some approaches may not be advisable
in certain contexts. For example a Human Capital Approach can lead to a low estimate in
low-income countries, mainly because of the economic environment in these countries.
The Willingness-to-pay approach also brings the income factor into the analysis, and can
skew the results towards the wealthy108. Some methods depend on results from other
studies109, which may not be available or may not be of good quality.

These methods of economic analysis have their own assumptions about societal
objectives. Understanding the level of congruence between our understanding of the
societal objectives and the assumptions embedded in the methods of economic analysis
is a pre-condition for using these methods.

Summing up

Sir Isaiah Berlin once wrote, “.......where ultimate values are irreconcilable, clear-cut
solutions cannot, in principle, be found. To decide rationally in such situations is to
decide in the light of general ideals, the overall pattern of life pursued by a man or a
group or a society." Decision making in public sphere is characterised by complexity and
contest between different viewpoints. The ambiguities of this state replete with divergent
questions, and the continuous changes adding to the complexity, can be quite

104 Sassi et al (2001)

105 Ibid.

106Ensor and Cooper (2004)

107Explained in Appendix 1

108 Coast (2004)

109 For example, a cost-effectiveness analysis is dependent on the quality of an effectiveness trial.

27
overwhelming. There may be a temptation to take refuge in a small box of relatively fixed
set of assumptions and ideas, and take this box to be the whole world.

The methods of analysis discussed in this note provide us with certain ways of looking at
the reality, and informing decisions. Considering methods of economic analysis as the
only tools of decision-making would be more dangerous than turning one’s back to
them. The methods of economic evaluation can help one choose the more efficient of
the alternatives, or help judge the merit of an intervention from the economic point of
view. Though this is an important question, it after the question of resource allocation in
the larger economy is answered. If the total allocation to health itself is low, optimal
prioritisation within the sector could only be of marginal help. The decision about
resource allocation in the larger economy may be informed by an analysis like Cost-of-
illness, but this analysis takes an excerpted view of the reality, and may under or over-
state the needs. To sum up, a wider set of methods and considerations should be used
for aiding such decisions, and where these methods are used, a critical understanding of
their assumptions, and modification of methods to adapt to the context are crucial for
their meaningful use.

28
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32
APPENDICES

Appendix 1: Some concepts

Economic Costs:

The idea of economic cost differs from the idea of financial (or accounting) cost in that it
includes the opportunity costs of the object of evaluation. The opportunity cost of a
product is the value of the next-highest-valued alternative use of that resource. Let us
take a simple example of a person leaving his job and choosing to pursue a professional
course. The fee of the course is the financial cost of the course, while the fee and the
salary foregone for the time of the course (i.e. opportunity cost) together constitute the
economic cost. The importance of this idea is a direct result of the limited resource
environment and the trade-offs it necessitates. Therefore, if we pay a certain sum for
building a hospital, the economic cost of the hospital is not just the money spent on the
hospital, but also the benefits foregone from not investing those resources into another
venture, the next best alternative in a given context.

The opportunity cost of investing in a healthcare intervention is best measured by the

benefits that could have been achieved had the money been spent on the next best
alternative intervention or healthcare programme110. This idea is important for analysing
costs from the economic point of view. For example, the government subsidy in health
usually covers only the financial costs incurred by people for using the services, but
does not cover the opportunity costs that they have to bear, which may be more than
the financial costs and may deter the poor from using the services.

Adjusting costs and effects for time factor:

A rupee tomorrow is worth less than a rupee today. If we put it to any productive use
today, we can expect to get more than a rupee tomorrow. This necessitates adjusting the
values for time factor while considering the economic costs and effects of intervention at
different points in time and presenting them in terms of values at a given point in time.
Another rationale for adjusting is that people have a positive time preference, meaning
they prefer consumption or benefits sooner rather than later111. Also, uncertainty about
the effectiveness of interventions and technological change can be reasons for weighting
some future benefits less highly112.

Most economic analyses studies involve estimating costs and effects at different points
in time. To allow comparison, costs and health effects spread over time need to be
weighted according to when they are experienced, with the costs and effects at one time
getting higher weight than those later, and collapsed into a single number (or a small set
of numbers) that give the present day value of all these costs and benefits. This requires
discounting of future costs and benefits and inflating of past costs and benefits.

Though process of discounting for economic costs is the same for different studies,
there may be some variations while adjusting health effects, depending on how the
health effects are presented. These variations are presented in the main text of this note,
as part of discussion on various methods of economic evaluation.
110 Russell (1992)

111 Sheldon (1992)

112 Ibid.

33
Not Discounting can show more favourable cost-effectiveness ratios compared with
when discounting is done, because the future costs and effects would also be taken to
be of the same weight as those of today. Including discounting may lead to a bias
towards short-term measures and may, due to lower weights to the future, make a case
against many preventive health programmes113,114, which may give benefits much later.
Thus, assigning appropriate rate of discount is crucial.

The assumed rate of annual return on investments is usually the rate of discount 115. It is
useful if a study provides estimates with multiple discount rates, so that the impact of
time and discount rates on costs can be understood. One of the ways of deciding about
the rate of inflation can be to link it with the Consumer Price Index116.

Formulae for calculating present value from future and past values:

Discounting: The following formula can be used for discounting a future cost figure:

Present Value = Future Value X [1/(1 + r) n],

where r is the rate of discount and n is number of years.

Example: If a cost two years from now is Rs. 100 and the discount rate is 10%, the
present value (after discounting) would be: 100 X (1 - 0.1)2 = 100 X 0.81 = Rs. 81

The following formula can be used for discounting a range of future cost figures:
Present discounted value = Σ [Ci/(1+r) i],
where Ci is the cost for the ith year from now, and r is the rate of discount.

Inflating: The following formula can be used for inflating a cost figure from the past for a
given rate of inflation with compounding:
Present Value = Past Value X (1 + r) n,
where r is the rate of inflation and n is the number of years.

The following formula can be used for inflating a range of past cost figures:
Present inflated value = Σ [Ci X (1+r) i],
where Ci is the cost from i years back, and r is the rate of discount.

If the Consumer Price Index is taken for inflation, the following formula can give the
present value:
Present Value = Past Value X (CYCPI/PYCPI),
where CYCPI = Current Year Consumer Price Index
PYCPI = Past Year Consumer Price Index

113 Torgerson and Raftery (1999)

114 Sheldon (1992)

115 Bernard and Anita (2002)

116 Choi and Pak (1996)

34
Marginal values:

Usually in an economic analysis, there are at least two variables, one independent and
the other dependent variable. For example, the resources used in an intervention can be
called an independent variable and an outcome can be called a dependent variable. One
can understand the interaction between these variables either by looking at marginal
numbers i.e. change in a dependent variable per unit change in the independent variable
at a given point, or looking at the average numbers i.e. total value of dependent variable
divided by total value of independent variable. For example, when considering the
interaction between the costs and delivery of facility-based management of severe
under-nutrition, one can either look at the average costs per child i.e. total costs divided
by the number of children, or we can look at the marginal costs at the given point i.e. the
cost of providing the service to each new beneficiary at that point in time. Most of time,
the decision is not about ‘either-or’, but about ‘how much’. In such situations, where the
quantity of the existing interventions is being considered, the marginal numbers are
useful, because they can tell about change in an outcome per unit change in the costs.
Marginal values are concerned with a unit change in production of the given
interventions; and the best mix of services is determined by examining the relative costs
and benefits of the various options, at the margin117.

Sensitivity Analysis:

Economic analysis often involves estimating values of multiple input variables, on the
basis of certain assumptions, and using them to arrive at summary measures. There is a
need to test the robustness of the results in response to variations in the value of the in-
put variables. Also, it is advisable to provide the results considering multiple scenarios in
terms of combination of values of variables, so that the reader can consider the results
most in line with his/her assumptions about those variables. For such purposes sensitiv-
ity analysis can be put to use. Sensitivity analysis tests the sensitivity of the results to
changes in the input variables going into the analysis. The analysis involves computing
the final results for different values for the input variables, based on variation in assump-
tions for estimating the input variables. This analysis will reveal the dependence of res-
ults on certain assumptions. Briggs et al (1993) have listed types of sensitivity analysis
for economic evaluation in health. One way of doing this analysis is to do a Simple
Sensitivity Analysis by varying one or more variables in the evaluation to see the sensit-
ivity to these values. Another way is to do Extreme Scenarios Analysis by estimating the
costs and effectiveness from the most optimistic (low cost, high effectiveness) and the
most pessimistic (high cost, low effectiveness) scenarios. This analysis can help in
choosing between different options, based on the criteria of risk and minimum cut-off set
by the decision makers. Sensitivity Analysis can also be done probabilistically by assign-
ing ranges and distributions to variables and selecting values randomly from these
ranges an computing the results for these selected values of variables

117 Mitton and Donaldson (2004)

35
 Appendix 2: Identification, Measurement and Valuation for a study on costing publicly
provided maternity services in a city of Argentina118.

Input Identification and measurement of Monetary Unit Valuation

Recurrent inputs
Hospital Health Centre Hospital Health Centre
Healthcare Staff lists Staff lists Full-time - Approximated salaries
and support - Discussion with - For staff with direct equivalent salary from salary codes
staff healthcare staff contact with pregnant for each staff - Apportioned salary
women, quantified total according to the
hours of work, number proportion of time
of hours allocated to allocated to ANC visits
outpatient visits, and
proportion of time
devoted to ANC
Drugs Hospital Records - Monthly invoices from Apportion drug Estimated average
April 1997 to March costs based on monthly drug cost and
1998 number of average cost of a typical
- Total number of prescriptions per prescription
prescriptions per month ward average
per drug category for prescription cost
pregnant women
- Typical prescription for
ANC based on
interviews with
obstetricians
Medical Invoices per month Monthly invoice for Total monthly - Apportioned average
materials per ward medical materials cost per ward monthly cost on basis of
and supplies proportion of visits for
ANC
- Assumed use of medical
materials is restricted to
nurses (60%and
obstetricians (40%)
- Apportioned to ANC on
the basis of the
proportion of staff
working on ANC
Non-medical
materials
Utilities Allocation based on Allocation based on Total monthly Total invoice for one
the surface area of number of room related invoices for month
each ward to ANC whole facility
Capital - Inventory of - Inventory of patients in Monthly equipment costs were calculated
Equipment equipment in outpatient rooms and using a linear discount factor.
obstetrics and nursery
neonatal wards - Replacement value
- Replacement obtained from local
value obtained from medical suppliers
local medical
suppliers
Building Measured size of Used number of rooms Monthly cost based on current construction
each ward as an estimate of area cost by area, adjusted for the life expectancy
Identified current Estimated total area of at new (linear discount rate)
cost of construction health centre
per square metre Identified current cost of
construction per square
metre

118 Borghi et al ( 2003)

36