Cost-effectiveness analysis and insurance coverage: solving a puzzle

The conventional model for the use of cost-effectiveness analysis for health programs involves determining whether the cost per unit of effectiveness of the program is lower than some socially determined maximum acceptable cost per unit of effectiveness. If a program is better by this criterion, the policy implication is that it should be implemented by full coverage of its cost by insurance; if not, the program should not be implemented. This paper examines the unanswered question of how cost-effectiveness analysis should be performed and interpreted when insurance coverage may involve cost sharing. It explores the question of how cost sharing should be related to the magnitude of a cost-effectiveness ratio. A common view that cost sharing should vary inversely with program cost-effectiveness is shown to be incorrect. A key issue in correct analysis is whether there is heterogeneity in marginal effectiveness of care that cannot be perceived by the social planner but is known by the demander. It is possible that some programs that would fail the social efficiency test at full coverage will be acceptable with positive cost sharing. Combining individual and social preferences affects both the choice of programs and the extent of cost sharing.