Methods for Cost Determination

Need to estimate costs? We frequently receive questions from researchers asking us how to estimate costs for their study. There are many methods by which one could use to estimate costs. Costs are most often thought of in accounting terms because we most frequently see costs in relation to bills. However, the economic cost and the accounting cost do not always agree. Economic costs are based on the concept of opportunity costs¹.
[ Learn more about opportunity costs ]

There is a spectrum of cost determination methods (see Figure 1). Accounting and billing systems use direct measurement methods, whereby very detailed estimates of time and products (inputs) are combined with unit costs to estimate total costs. The highly precise methods, such as direct measurement, are extremely challenging because a single inpatient stay or outpatient procedure might have hundreds or thousands of inputs. Even when there is just a single input, such as a pill of medication, the cost can vary by location or day. Researchers can use less precise methods, such as an average cost per day. These methods are easier than the more precise methods to use, but their ease of use comes at a cost of decreased precision. Researchers need to identify the level of precision necessary for their study.

Blending two or more methods in a study is frequently needed because a researcher might need to estimate the cost of an intervention and the cost of subsequent health care. Different methods may be ideal for each of these goals. After we describe the methods, we discuss which method is best.

On precision and accuracy: Direct measurement is more precise than an average cost per day. This added precision might not yield greater levels of accuracy. Researchers should choose a method that offers a sufficient amount of precision and then work to validate the accuracy of the data.

Most researchers are not able to directly measure the cost of health care. Such a task would require considerable time, resources, and very detailed production data.

Researchers sometimes use direct measurement to estimate the cost of an intervention. For example, a study that compared outreach workers and usual care to improve smoking cessation would need to use direct measurement to estimate the cost of the outreach workers. To directly measure the costs, the research would need to identify the quantity and prices of all inputs, such as labor, space, supplies, contracts, training and quality assurance.

A related method is activity-based costing. This approach was used to create the VA Decision Support System (DSS) workload and cost estimates. Researchers have access to many DSS data extracts.
[ Learn more about Micro-Cost Methods: Direct Measurement ]
[ Learn more about the Decision Support System (DSS) ]
[ FAQ # C1: How should I measure the activities of staff involved in providing an intervention? ]
[ FAQ # C2: How can I find the cost of employing a specific type of VA staff? ]
[ FAQ # C3: How can VA capital costs be determined? ]

The pseudo-bill method combines VA utilization data with unit costs from non-VA sources to estimate the cost of patient care. This is commonly referred to as the pseudo-bill method because the itemized list of costs is analogous to a fee-for-service hospital bill. The unit cost of each item may be estimated by using Medicare reimbursement rates, the charge schedule of an affiliated university medical center, or some other non-VA source. We used this method to estimate outpatient costs in the HERC Average Cost Dataset.
[ Learn more about Pseudo-Bill ]
[ Learn more about the HERC Average Cost Outpatient Dataset ]

The reduced cost list is similar to the pseudo-bill method, except that only a limited itemized list is used. Ideally, the list is limited to those items that account for the majority of the costs.

The cost regression method requires detailed cost and utilization data for a specific, non-VA service to simulate the cost of a comparable VA service. If suitable non-VA data are available, a regression can be estimated using cost-adjusted charges as the dependent variable and information about the encounter as the independent variable. VA costs are simulated using VA utilization data and the function’s parameters. The chief advantage of this method is that it requires less data than is needed to prepare a pseudo-bill, making it a more economical way of micro-costing. We used this method to calculate the inpatient costs of the HERC Average Cost Dataset.
[ Learn more about Micro-Cost Methods: Estimating Cost Regression ]
[ FAQ # E1: How do I estimate costs with a clinical cost function? ]
[ Learn more about the HERC Average Cost Inpatient Dataset ]

Medicare uses DRGs to assign inpatient payments and CPT codes for outpatient payment. Researchers can use this information to calculate an expected Medicare payment. The process of estimating Medicare payments is complex because payments are adjusted to account for regional wage differences and individual hospital factors.
[ FAQ # I12: How can I estimate Medicare payments for an inpatient short-stay acute hospitalization? ]

This method assumes that the cost of an inpatient stay is directly proportionate to the length of stay. We used this method for rehabilitation, mental health and long term care in the inpatient HERC Average Cost Dataset. This method is also frequently used to estimate costs when the utilization data come from participant self-report.
[ Learn more about the HERC Average Cost Inpatient Dataset ]

The best method to use depends on the level of precision required. Usually a researcher uses a more precise method to estimate the cost of care associated with an intervention or the issue under study, and a simpler, less precise method to find the cost of other unrelated care.

The analyst must consider whether the assumptions used to create average cost estimates are appropriate to all utilization within the study; for example, whether the intervention might affect the cost of hospital stays in a way that will not be captured by the DRG or length of stay, or whether it will effect the cost of ambulatory visits in a way that will not be captured by the relative value units associated with CPT codes.

1. Garber, A. M. 2000. Advances in cost-effectiveness analysis of health interventions. In Handbook of Health Economics, edited by A. J. Culyer and J. P. Newhouse. Amsterdam: Elsevier Science.

To ensure the protection of VA information, we have restricted access to certain files (denoted by the "lock" icon). Contact HERC to download these restricted files.

• Comparison Between DSS National Data Extracts and HERC Average Costs: Aggregate and Person-Level Costs, FY2001

  Date: 5/1/2004 | Size: 909Kb

• A Comparison for Inpatient Costs from the HERC and DSS National Data Extract Datasets

  Date: 1/1/2004 | Size: 1.22Mb

• Smith, M. W.; Barnett, P. G.. Direct measurement of health care costs. Med Care Res Rev 2003;60(3 Suppl):74S-91S. 

• Barnett, P. G.. Determination of VA health care costs. Med Care Res Rev 2003;60(3 Suppl):124S-141S. 

• Barnett, P. G.. Review of methods to determine VA health care costs. Med Care 1999;37(4 Suppl Va):AS9-17.