Health economics, a popular subject in recent times on account of its social security dimension and its ballooning cost worldwide, examines healthcare systems, consumption patterns, incentives and behaviours affecting health. It focuses on the allocation of healthcare resources, the mechanisms of allocation, its efficiency and efficacy, as well as the containment of cost and assurance of quality.

The application of health economics reflects a general desire to attain the best value for money by guaranteeing not only medical effectiveness, but also the cost-effectiveness of healthcare provision. The related concept of efficiency is also important in health economics. Broadly speaking, there are 3 concepts of efficiency.

Another well-renowned concept in economic theory is that of opportunity cost. This concept also stands for a particularly useful mode of thought in health economics as it makes clear the trade-offs underlying resource use in healthcare services.

  • Technical efficiency relates to the ratio of outputs to inputs. The higher this ratio, the more technically efficient a healthcare system may be deemed to be, provided that there are no biases in the way that inputs and outputs are being measured.
  • Allocative efficiency looks at how well resources are utilised in order to realise a desired result. Theoretically, allocative efficiency is said to occur when health services consumers pay a market price that reflects the private marginal cost of production and the market for health services clear. In practice, however, we know that the peculiarities underlying the health services market (such as strong asymmetric information in contexts where the principal is not the agent) make for market failures and inefficiencies that disallow this theoretical ideal of allocative efficiency from being fulfilled.
  • Socioeconomic efficiency, lastly, exists when all the private and external costs and benefits are taken into account when producing healthcare services. Private healthcare services providers only have an incentive to take external costs and benefits into account if they are forced to internalise them, whereas public healthcare services providers usually decide on internalisation policies after they receive their incentive mechanism structure politically through command and control instructions and the budget made available.

An influential 1963 article by Kenneth Arrow, frequently credited with giving rise to the field of health economics provided an analysis of the healthcare market and its theoretical differences with respect to other markets. Half a century later, this analysis still applies. Healthcare managers confront numerous exceptional challenges that are unique to the health sector. Since risk and uncertainty are inherent in healthcare, most consumers possess health insurance. Consequently, healthcare organisations have to contend with the management issues that insurance gives rise to. Healthcare services providers at times ensure that this is the case through the provision of advice. With health insurance, uncertainty with respect to who the customer is exists. Customers are the ones using the products/services, but insurance plans frequently pay most of the bill. As a consequence, most patients over-consume health services and sometimes opt for the most costly treatment even if a cheaper treatment is likely to be as effective.  Insurers utilise various methods to control this so-called moral hazard (a commonly-observed phenomenon where a party has a tendency to take risks because the costs that it could incur will not be taken on by the party taking the risk) and the costs associated with it. Such methods include imposing co-payments on patients and restricting the healthcare provider’s incentives to offer expensive treatments. Moreover, information asymmetries are widespread in healthcare markets and generate additional problems. The more informed party (the healthcare services provider) has the possibility to take advantage of the less informed one (the patient). The patient, as the less informed party, could also become dubious of the other party’s incentives and refuse a potentially beneficial recommendation on that basis.

As a public good offered, at least in basic terms, at no cost to the entire population in EU Member States, health care is a large and continually rising part of public finances. Seeing that a considerable rise is also likely in government spending on pensions, long-term care and other age-related components of social spending, European governments face the rising possibility of undermining long-term sustainability of their public finances. The Council of the European Union has described the challenge facing the European Member States as the necessity to have financial sustainability of their health systems without deterioration in the principles that these healthcare systems share: universal coverage, solidarity in funding, equity of access and the provision of high-quality healthcare.

Private finance may also be relied on as a solution. However, private health insurance markets in the European Union health structures usually serve the affluent and better-educated strata of society, while causing barriers to access for the elderly and the least healthy strata. Frequently, insurance markets are fragmented, resulting in weak purchasing power. Furthermore, they might have a strong motivation to choose risks, which may result in reduced equitable access and efficiency. Generally speaking, private systems incur significantly larger transaction costs than public systems and as a result, can be accused of lessening administrative efficiency. European Member States have made considerable efforts to advance equitable access to healthcare – by increasing coverage, improving private health insurance regulation, improving the design of cost sharing, and by planning better the distribution of resources.

Health Economics analytics usually makes use of classification systems for hospital patients such as Diagnosis-Related Groups (DRGs) and Healthcare-Resource Groups (HRGs). The system also makes the management of health-related payments easier.

In the United States of America (USA), a DRG assignment to a case is based on the patient’s principal diagnosis, performed treatment process, age, gender and discharge status. The system provides a method of linking hospital patient types with the cost and resource expenses incurred by the hospital to treat them. While originally developed and utilised in the USA, the system is now used in various countries throughout Europe under different names. The system’s principal aims are increasing transparency, efficiently allocating healthcare resources and assuring quality in hospitals. In the United Kingdom (UK), HRGs, which comprise a system for classification similar to DRGs, are used. This system involves categorising patient events which have been judged to consume similar resource levels.

As the use of DRG flat rates to compensate acute inpatient treatment grows, a common problem is the determination of whether inpatient emergency services should be compensated separately from DRGs or as part of them. Throughout the world, there are different ways of dealing with such remuneration.

By way of illustration, in France an annual flat rate based on emergency ward/department size is paid to remunerate emergency readiness. In Australia, emergency services are classified into seven levels in relation to their roles and staffing. 80% of emergency costs (for both inpatient and outpatient cases) are paid by an emergency readiness budget. To this end, the planned cases are weighted by the Urgency and Disposition Groups emergency patient classification system. This grouping defines 11 patient categories.

A substantial part of health economists’ work consists of economic evaluation. The idea of economic evaluation underpins efficiency choices in healthcare. It connects the benefits of alternative interventions to the resources used in their production.

Every economic evaluation has a common structure involving explicit measurement of costs and benefits. Outcomes are measured in terms of improved survival (adding years to life), improved Quality of Life (QoL) (adding life to years), or both. Progressively more health services are now focusing on bettering QoL (for instance, through less pain). QoL measure how the social, emotional and physical aspects of life are affected by a particular treatment from the patients’ viewpoint. The most common method used by health economists to place values on different health states is the quality-adjusted life year (QALY). The QALY notion is based on the belief that health services interventions seek to improve both survival and QoL. Through the application of quality weights with respect to every additional year of life experienced after treatment, the QALY provides a single measure for both of these elements. Despite its popularity, the use of QALYs is contested in a number of areas due to ethical considerations.

Economic evaluation offers an organised and objective structure to compare costs and benefits. This comparison can help decision-makers make more informed choices. Various techniques are utilised to carry out economic evaluation:

  1. Cost-minimisation analysis – this is limited to circumstances in which the health benefits of healthcare treatments have been demonstrated to be the same. Here, the treatment incurring the lowest cost is chosen.
  2. Cost-effectiveness analysis – this is the most frequently applied technique within health economics. It is utilised to compare the financial costs of therapies with the outcomes which can be assessed purely in terms of health effect. This technique is often utilised in drug therapy.
  3. Cost-utility analysis – here the cost is calculated in terms of survival and QoL. Given that the endpoint may possibly not depend directly on the disease state, this technique can, theoretically, compare courses of action in diverse areas of medicine. In practice, this is not so easy with philosophical and technical criticism having been levelled at this method.
  4. Cost Benefit Analysis – here, the benefit is calculated as the associated economic benefit of an intervention; therefore, both costs and benefits are monetised (i.e. expressed in monetary terms). This technique may disregard many intangible but significant benefits which are hard to quantify monetarily. The advantage of this analysis is that it allows comparisons to be made between schemes in highly diverse areas of healthcare, and even with methods outside the field of medicine. This method is, however, not broadly accepted for use in health economics.
  5. Multi-criteria analysis – this is a decision-making tool used to assess a problem by ranking alternative interventions/treatments based on various criteria. It permits the transparent integration of multiple and potentially conflicting objectives into the analysis and is therefore useful to solve complex problems. The health sector faces numerous objectives and constraints, such as efficiency, inequality reductions, and budgetary constraints. Multi-criteria analysis is able to translate the different units with which these different objectives and constraints are measured into a single measurement, thereby allowing a direct comparison of different possible treatments.

Equinox Advisory provides services in the following areas of health economics:

  • Asset valuation;
  • Cost-effectiveness, cost-utility, and budget-impact models and analyses;
  • Economic evaluation studies;
  • Incentive Mechanism Design;
  • Market assessment;
  • Patient-level data analysis;
  • Pricing decision-making and analysis;
  • Quantification of burden of illness;
  • Regulatory and policy analysis; and
  • Resource utilisation studies.

For more information about our Health Economics services, please contact us here.