A. General Cost-Effectiveness Analysis Issues

4. How do I discount healthcare costs that are not incurred until the future?

Discounting reflects the loss in economic value that occurs when there is a delay in realizing a benefit or incurring a cost. Cost-effectiveness analysis incorporates the economic fact that costs and benefits that are deferred have lower value than those that are realized immediately.

Discounting should not be confused with adjustment for inflation. All costs should be expressed in real terms (adjusted for inflation) before discounting is done.

Both cost and outcomes should be discounted. Failure to discount outcomes as well as costs can result in a paradox described by Keeler and Cretin (1983). If costs are discounted, and outcomes are not, the cost-effectiveness of an intervention can always be improved by delaying its implementation indefinitely.

Costs and outcomes enter into the cost-effectiveness analysis expressed in their present discounted value. Most analysts discount on an annual basis. Expenses incurred in the first year are not discounted. If a discount rate of 3% is chosen, then expenses incurred in the second year are discounted by 3%, that is, they are divided 1.03. Third year expenses are divided by (1.03)². Each successive year is discounted by an additional 3%.

The present value (PV) of costs incurred by a subject from the first year of the study (t=1) until the study ends (t=n) is thus:

Present Value of Cost

Note that Ct represents the cost incurred in year t, and that i is the discount rate, e.g., .03. The present value of outcomes is calculated in the same manner.

What is the Appropriate Rate of Discounting?

A discount rate of 3% was recommended by the Public Health Service Panel on Cost-Effectiveness in Medicine (Lipscomb, et al, 1996). The Panel recommended that an alternative analysis be done with a 5% discount rate, so that results are comparable to those studies that use this higher rate.

Simplification for Costs and Benefits Realized at a Constant Rate.

When either cost or outcomes are realized at a constant rate, a formula may be used to find their discounted present value.* It can be used for models that assume that annual healthcare cost are incurred at a constant rate. It can also be used to find discounted life-years of remaining survival. The formula incorporates a discount factor (r):

which includes the discount rate (i). Other variables in the formula are the annual rate at which costs are incurred (a) and the number of years over which they will be incurred (n).

Present Value of Cost

The formula can also be applied to outcomes. If it is assumed the quality of life of the remaining years of survival is constant, then (a) represents the quality of life adjustment. If the outcomes are measured in life years, this factor takes a value of one, and drops out of the equation.

* This is the formula for a finite geometric series. A finite geometric series consists of a series of terms. The ratio of each term to its predecessor is a fixed constant (r):

The value of a geometric series (Sn) may be determined by subtracting r(Sn) from both sides of the equation, and applying simple algebra to yield:

References

EB Keeler, S Cretin. "Discounting of life-saving and other non-monetary effects." Management Science 29:300-306, 1983.

J Lipscomb, MC Weinstein, and GW Torrance. "Time Preference", Chapter 7 in Gold, M. R., J. E. Siegel, L. B. Russell, M. C. Weinstein. Cost-effectiveness in Health and Medicine. New York: Oxford University Press, 1996.