An economic evaluation is a study that compares the (costs and results) of two or more available interventions or services.

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Pharmacoeconomics Lectures 1+2
Principles of Pharmacoeconomics
Background
An economic evaluation is a study that compares the (costs and results) of two or more
available interventions or services.
Assessing the clinical effectiveness of any new health care intervention, including
medications, is very important in determining the role of the new intervention in clinical
practice, but the new interventions may provide only a modest advantage (or no
advantage) over existing intervention with a higher cost. Pharmacoeconomics attempts to
measure if the added benefit of one intervention is worth the added cost of that
intervention (1)
.
Pharmacoeconomic study is one field of economic evaluation which deals with the
description and analysis of the costs of health care interventions and their impact on
health systems and society. pharmacoeconomic identifies, measures, and compares
the costs and results of pharmaceutical products and services.
To show this graphically, think of two sides of an equation (Fig. 1.) (1)
.
The left-hand side of the equation represents the inputs (costs) used to obtain and use
the pharmaceutical product or service. The right-hand side of the equation represents the
health-related outcomes produced by the pharmaceutical product or service. The center
of the equation, the drug product or service being assessed, is symbolized by Rx.
If just the left-hand side of the equation is measured without regard for outcomes, it is a
cost analysis (or a partial economic analysis). If just the right-hand side of the equation is
measured without regard to costs, it is clinical or outcome study (not an economic
analysis) (1)
.
To be a true pharmacoeconomic analysis, both sides of the equation must be
measured and compared. Theoretically, at least two options must be compared in
pharmacoeconomics, but some assessments consist of a "with or without" comparison,
estimating what would occur if the product or service was provided (e.g., immunization or
pharmacy clinic services) compared with no provision of the product or service (1)
.
Figure 1. Basic pharmacoeconomic equation. Pharmacoeconomic studies compare the
costs (left box) associated with providing a pharmacy product or service (represented as
Rx) to the outcome of the product or service.

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Some questions that pharmacoeconomics may help to
address are as follows (2)
:
1-What drugs should be included on the hospital formulary?
2-What is the best drug for a particular patient?
3-What is the best drug for this particular disease?
4-What are the patient outcomes of various treatment modalities?
Relationship of Pharmacoeconomics to Other Research
Health care economics encompass a broad range of topics, including supply and demand
for health care resources, the effects of health insurance, and manpower supply. Clinical or
humanistic outcomes research should identify & measure the end results of health care
services and may include other outcomes such as patients' health status and satisfaction
with their health care.
If the research involves economic and clinical outcome evaluations with comparisons
of pharmacy products or services, it can be termed a pharmacoeconomic study (1)
.
Consequences (results, benefits, outcomes)
Similar to costs, the outcomes or consequences of a disease and its treatment are an
equally important component of pharmacoeconomic analyses. The manner in which
consequences are quantified or measured is a key distinction among
pharmacoeconomic methods because the assessment of costs is relatively standard (3)
.
Depending on perspective, the outcomes of health care are variable. The clinician has
traditionally been most concerned with clinical outcomes of treatments. More recently,
healthcare payers and administrators have focused on the resource use or economic
outcome of healthcare decisions. Patients, on the other hand, are seeking more
information regarding the humanistic outcomes of therapy. Patients want to know how
their quality of life will be affected or how satisfied other patients with their condition
have been with various treatments.
The consequences (or outcomes) of medical care can be categorized into three categories:
economic, clinical, and humanistic. Economic outcomes represent the reductions in
overall costs of the standard health services.
Clinical outcomes are the medical events that occur as a result of the treatment (e.g.,
safety and efficacy end points).
Humanistic outcomes are the consequences of treatment on patient functional status or
quality of life along several dimensions (e.g., physical function, social function, general
health and well-being, and life satisfaction).
Assessing the economic, clinical, and humanistic outcomes (ECHO) associated with a
treatment alternative provides a complete model for decision making (3)
.

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To give an opinion about the total outcomes of a health care intervention, there should
be sufficient measurement & description of all outcomes (clinical , economic &
humanistic). The true value of healthcare interventions, programs, and policy can be
assessed only if all three dimensions of outcomes are measured and considered (2)
.
Positive versus negative consequences
The outcomes can be categorized from another point of view as positive or negative. An
example of a positive outcome is a desired effect of a drug (efficacy or effectiveness
measure), possibly manifested as cases cured, life-years gained ……etc (3)
.
Since all drugs have adverse effects, negative consequences also can occur with their use.
A negative outcome is an undesired or adverse effect of a drug, possibly manifested as a
treatment failure, an adverse drug reaction (ADR), a drug toxicity, or even death.
Pharmacoeconomic evaluations should include assessments of both types of outcomes.
Evaluating only positive outcomes may be misleading because of the potential detriment
and expense associated with negative outcomes (3)
.
(The nature and assessment of costs in healthcare)
Identifying costs:
It is important to take into account all the costs associated with an intervention, not just
acquisition market prices. Calculation of true economic cost is difficult, but it is essential
to make sure that cost information reflects true economic cost as closely as possible.
This is not usually straightforward in healthcare. For example, prescribing the highly
effective antipsychotic drug clozapine for a person with schizophrenia does not just incur
the costs of buying the drug. Clozapine can have serious side effects, and so regular blood
monitoring tests have to be carried out in all patients. Therefore, these monitoring costs
must be taken into account when the economic implications of using clozapine are being
analysed. A very small number of patients experience serious side effects that require
hospitalization and treatment, and these costs must also be identified and measured (4)

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Types of costs
Economic studies use a range of costs. It is important to be able to distinguish between the
different types of costs that are used. Costs are usually divided into direct, indirect and
intangible (Figure 2) (4)
and table 1 (1)
.
Figure 3 types of costs (4)
TABLE 1. EXAMPLES OF TYPES OF COSTS
Type o f Cost
Category
Examples
Direct medical
costs
• Medications • Medication monitoring • Medication administration
• Patient counseling and consultations • Diagnostic tests
• Hospitalizations •Ambulance services •Nursing services
Direct
nonmedical costs
• Travel costs to receive health care (bus, taxi or aircraft)
• Hotel stays for patient or family for out-of-town care
• Child care services for children of patients
Indirect costs • Lost productivity for patient
• Lost productivity for unpaid caregiver (e.g., family member, neighbour, friend)
• Lost productivity because of premature mortality
Intangible costs • Pain and suffering • Fatigue • Anxiety
1-Direct Medical Costs
Direct medical costs are the most obvious costs to measure. These are the medically
related inputs used directly to provide the treatment. Examples of direct medical costs
include the costs associated with the pharmaceuticals, diagnostic tests, physician visits,

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pharmacy visits, emergency department visits, and hospitalizations.
Example: during chemotherapy treatment, direct medical costs may include the
chemotherapy products themselves, other medications given to reduce side effects of the
chemotherapy, intravenous supplies, laboratory tests, clinic costs, and physician visits (1)
.
2-Direct nonmedical Costs
Direct nonmedical costs are costs to patients and their families that are directly associated
with treatment but are not medical in nature. Examples of direct nonmedical costs
include the cost of traveling to and from the physician's clinic, or the hospital; child care
services for the children of a patient; and food and lodging required for the patients and
their families during out-of-town treatment.
Using the example of chemotherapy treatment, patients may have increased travel costs
related to traveling to the clinic or hospital. They may also have to hire a babysitter for the
time they are undergoing treatment (1)
.
3-Indirect costs
Indirect costs are incurred by the reduced productivity of a patient and their family,
resulting from illness, death or treatment. They may include time off work or; time spent
caring for the patient by relatives. Only the following indirect costs can be calculated
reliably from data:
A-Time off work due to sick leave
B-Early retirement
C-Reduced productivity at work.
The significance of indirect costs depends upon the particular illness and treatments
involved. Diseases such as asthma, migraine and depression affect working age groups,
whereas other diseases, such as Alzheimer's, do not.
Indirect costs are difficult to measure and sometimes are underestimated in certain patient
groups like children, housewives, nonworking and the elderly. Because of the difficulties
concerning indirect costs, they are not often included in economic studies. However, they
should always be considered, if not measured (4)
because they have a dramatic effects on
the results of economic analysis.
4-Intangible costs
Intangible costs are difficult or impossible to measure, but they still occur and it is of value
to identify them. They can include anxiety, pain or suffering from an illness or treatment
(4)
.
Fixed, semifixed and variable costs (4)
The costs of healthcare can be split into fixed costs & variable costs. There is an
intermediate category called semifixed costs.
1- Fixed costs
These costs are incurred whether patients are treated or not. Examples include building
hospitals or counseling rooms, costs of equipments & instruments.

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2- Variable costs
These costs are incurred from patients' treatment. They include disposable equipments,
drugs, blood products & investigations.
3- Semifixed costs
These costs virtually refer to staff costs. Staff costs may vary directly with activity and
here they can be considered as variable costs. However, staff costs may increase only
when there is a large increase in activity and here they can be considered as semifixed
costs.
Incremental costs and marginal costs
The terms incremental cost and marginal cost are often used in economic evaluations. An
incremental cost is the difference in overall costs between two alternatives. A marginal
cost is the cost of carrying out one more intervention (4)
or expanding a programme or
service (e.g. increasing the length of stay in hospital by one day) (5)
.
Opportunity costs
Represent the economic benefit forgone when using one therapy instead of the next best
alternative therapy. Therefore, if a resource has been used to purchase a program or
treatment alternative, then the opportunity to use it for another purpose is lost. In other
words, opportunity cost is the value of the alternative that was forgone (3)
.
Consider, for example, two possible interventions: a cancer screening program
(intervention A) and a smoking cessation program (intervention B). If only one of these
interventions can be funded then the opportunity cost of funding A can be thought of as
the number of life years that would have been gained through the smoking cessation
program (5)
.
Average cost
Average cost is calculated by dividing the total costs for the intervention by the total
quantity of treatment units provided, such as the number of patients receiving a course of
antibiotics (5)
.
How are costs valued?
The two ways of collecting costs are either 'top down' or 'bottom up' (also called
microcosting). Top-down studies use the total budget to produce average costs per patient.
This method is the quicker one, but assumes that all patients have the same diagnosis,
severity of illness and treatment.
Bottom-up studies measure resource use by individual patients and so are able to detect
treatment differences between patients. This method produces much better quality costs,
but can be time-consuming and expensive (4)
.

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When to stop collecting costs
It is important to carry on collecting information about resource use until it is clear that no
more events are likely to occur related to the original intervention (4)
.
These events may be further interventions, such as treatment, or they can be side effects of
the intervention, and consequences of failed treatment. The study must carry on collecting
cost information until all these events have stopped occurring. This may be a month, a
year, or longer, depending on the type of intervention or illness being treated. The time
when costs are no longer collected should coincide with when outcomes are also no longer
going to be collected and is called the time horizon (4)
.
Often, trials do not continue with such a long-term follow-up period because of expense,
and a shorter time horizon will be employed (4)
.
Timing Adjustments for Costs
1-Bringing Past Costs to the Present: Standardization of Costs
When costs are estimated from information collected for more than 1 year before the
study, adjustment of costs is needed; this is also referred to as standardization of costs. If
retrospective data are used to assess resources used over a number of years back, these
costs should be adjusted to the present year (1)
.
If you compared costs for patients who received treatment in 2000 with patients who
received treatment in 2005, the comparison of resources used would not be a fair compari-
son because treatment costs tend to go up each year, so patients who received the same
treatment in 2000 would have lower costs than those who received the treatment in 2005.
Adjustment of the 2000 costs to the amount they would have cost in 2005 is needed before
a direct (fair) comparison can be made between these groups (1)
.
For example, if the objective of the study is to estimate the difference in the costs of two
different chemotherapy regimens, information on the past use of these two treatments
might be collected from a review of medical data which was collected before more than
one year. It is necessary to standardize the cost of both medications by calculating the
number of units (doses) used per patient and multiplying this number by the current cost
of the present year for each medication (table 2.2).
Another method of standardizing costs is by multiplying all of the costs from the year the
data were collected by the medical inflation rate for that year (Table 2.3).
Medical Consumer Price Index (CPI) inflation rates can be found at the Bureau of Labor
Statistics' website (www.bls.gov) and have been between 4% - 5% each year since 2000
(1)
.

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2-Bringing Future Costs to the Present year: Discounting
If costs are estimated based on dollars spent or saved in future years, another type of
modification, called discounting, is needed. There is a time-value associated with money.

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People (and businesses) prefer to receive money today rather than at a later time.
Therefore money received today is worth more than the same amount of money received
next year (1)
.
Modifications for this time value are estimated using a discount rate. From this parameter,
the present value (PV) of future expenditures can be calculated. The discount rate
generally accepted for health care interventions is between 3% and 6%.
The discount factor is equal to 1/ (1 + r)
t
where r is the discount rate and t is the number
of years in the future that the costs occur (1)
.
For example, if the expenses of cancer treatment for the next 3 years are $5,000 for the
first year, $3,000 for year 2, and $4,000 for year 3, discounting should be used to
determine total expenses in present value (PV) terms.
If one assumes that the expenses occur at the beginning of each year, then first year costs
are not discounted (see Table 2.4) (1)
.
It is equally acceptable to assume that expenses occur at the end of the first year (12
months later) and therefore, they are discounted (see Table 2.5) (1)
.

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This example illustrates the impact of discounting the costs of an intervention using
information from a theoretical hip replacement operation compared to drug treatment for a
patient with osteoarthritis (4)
.
Intervention
Costs (£) arising during
Year O Year 1 Year 2 Year 3 Year 4
Hip replacement 5,000
Painkillers (undiscounted) 1,000 1,000 1,000 1,000 1,000
1-What are the total costs for a hip replacement?
The total cost for the hip replacement operation is £5,000.
2-What are the total costs for drug treatment?
The total cost for the drug treatment is £5,000.
3-What is the impact of discounting the costs?
The costs for the hip replacement all occur in the first year (now) This means that they
should not be discounted (4)
.
The costs for drug treatment occur over a 5-year period. This means that they must be
adjusted for discounting. In the analysis, future costs must be given less weight because
they have a lower impact than an equivalent cost occurring now. The further in the future
the cost, in terms of years, the less weight they are given (4)
.
Using the above formula and discount rate of 3.5% we can calculate the discount factor for
each year.
The discounted costs are calculated by multiplying the discount factor by the costs for
each year (4)
.

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This example shows that when discounting is taken into account, drug treatment over 5
years period is cheaper than hip replacement (4)
.
Therefore, future costs have to be discounted in any economic evaluation. Studies will
generally discount costs if the intervention lasts more than 1 year (4)
.
Cost of illness
The cost of illness (COI) is the personal cost of acute or chronic disease. The cost to the
patient may be economic, social or psychological, ………etc.
The direct medical costs of illness include diagnosis, medical treatment, surgery and
follow-up care (4)
. Indirect costs of illness are costs attributable to loss of productivity of
patients with that disease or condition (1)
.
Intangible costs of illness are the pain and suffering associated with illness (4)
.
COI studies are used to indicate the magnitude of resources needed for a specific disease
or condition, and they may be used to compare the economic impact of one disease versus
another (e.g., costs of schizophrenia versus costs of asthma) or the economic impact of a
disease on one country compared with another (e.g., costs of D.M in Iraq versus costs of
D.M in Jordan) (1)
.
The point of treating a patient with a disease is to reduce these costs of illness (4)
.
References:
1-Karen L.Rrascati. Eessentials of Pharmacoeconomics. copyright 2009 Lippincott
Williams and Wilkins.
2-Bootman JL, Townsend RJ, McGhan WF, (Eds.), Principles of Pharmacoeconomics,
Harvey Whitney Books Company, Cincinnati.
3- Joseph T. DiPiro, Robert L. Pharmacotherapy: A Pathophysiologic Approach, Sixth
Edition. 2005.
4-Rachel Elliot and Katherine Payne .Essential of economic evaluation in healthcare.
2005 pharmaceutical press.
5-Rachael Fleurence. An introduction to health economics. The pharmaceutical journal
(vol 271) 15 November 2003. Pages: 679-681.