- Insight
11 min read
1st February 2024
Looking Further Afield – What Can Health Economics Learn from the Environmental Economics Approach to Discounting?
Discounting in economic evaluations presents challenges for therapies with high up-front costs and long-term benefits. We discuss how health economics can learn from debates occurring within environmental economics, where discounting poses similar challenges.
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What is discounting, and why does it matter?
Discount rates are adjustments applied to costs and health effects in economic evaluations that aim to reflect the notion that people value future costs and benefits less than those that occur now. The further into the future costs and effects fall, the less they are valued through the impact of discount rate compounding. Discounting applies when considering future costs and benefits across a range of sectors, such as during health technology assessment (HTA) or when evaluating environmental policies.
The impact of discounting is seen most clearly when costs and benefits occur at different points in time. In a healthcare context, this is most apparent when evaluating advanced therapy medicinal products (ATMPs), medicines based on cells, tissue, or genes. ATMPs are associated with substantial benefits over the patient’s lifetime but also high up-front costs, often in the form of a single payment for a one-time therapy. It follows that discounting has little to no impact on the incurred intervention costs but substantially devalues the benefits of ATMPs, thereby disadvantaging them from a cost-effectiveness standpoint relative to non-ATMPs.
This phenomenon raises the question of whether the standard approach to discounting puts an insurmountable barrier between patients and potentially transformative medicines because the benefits occur later in life.
That ATMPs are disadvantaged by discounting is indisputable, but there is less consensus on whether discount rates should be selectively altered to address such issues. The National Institute for Health and Care Excellence (NICE) in England usually discount at a rate of 3.5% (see box 1), but state a lower 1.5% non-reference case rate may be applied to treatments that restore the health of those who would otherwise die or have a very severely impaired life to full or near full health, when the benefits are sustained over at least 30 years. However, this has rarely been implemented, and the selective aspect has been criticised for creating inconsistencies and incentives for strategic behaviour by manufacturers. It is, therefore, imperative to explore alternative approaches that address the challenges faced by ATMPs as a result of discounting.
To identify alternatives, we may benefit from looking further afield. Climate change policies are similar to ATMPs in that they incur high up-front costs, but the benefits, or avoided damages, occur many years from now. Discounting heavily reduces the value of benefits relative to costs, weakening the case for climate change mitigation policies.
Discounting within environmental economics has comparable implications with health economics in terms of choosing which policies are funded. In the context of climate change, there exist discounting policies, or at least an established debate around discounting policies, which seek to address some of these concerns. We explore a mix of technical and ethical rationales for change from which health economics can learn.
Box 1: How is the discount rate estimated?
While the general concept of discounting makes intuitive sense, numerous factors are involved in setting the rate at a level that optimises resource allocation. Different countries follow different approaches and use different values when setting what is termed the social discount rate (SDR), which is the discount rate used by governments for the costs and effects of social projects. HTA guidelines commonly refer to the SDR used by government finance departments as the basis for their recommended rates. The SDR is calculated by using either side of the Ramsey Rule, an equation explained in further detail in Figure 1:
Figure 1: The Ramsey Rule
There are two schools of thought relating to which side of the Ramsey Rule should inform the SDR:
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- Social Opportunity Cost of Capital (SOC) (left-hand side) – Reflects the idea that public funds could be invested into the private sector for a return, r, if not used for public projects. If the SDR is below the private sector interest rate, it might not cover the productivity foregone from not investing in the private sector. The SOC approach views discounting from an efficiency perspective.
- Social Rate of Time Preference (SRTP) (right-hand side) – Reflects the idea the SDR should be based on societal preferences for current consumption over future consumption, and the impact of future economic growth on the welfare we derive from consumption. It is calculated by adding up estimates of each component.
There is debate regarding which method is the most suitable for setting the SDR. It has been argued that the SRTP approach is more appropriate for evaluating public expenditure, as is done when utilising cost-effectiveness analysis for publicly funded health systems. The UK utilises the SRTP approach to inform the UK treasury SDR of 3.5% (see figure 2). NICE uses this rate for discounting costs and effects, citing the treasury’s recommendations.
Figure 2: The UK Treasury Social Discounting Rate
Lessons from further afield
#1 – Dropping the ‘wealth’ component could lower discount rates.
Society and the individuals within that society are expected to become wealthier over time due to positive economic growth. A wealthier society is able to produce more of each good, as well as a wider variety of goods. When a good becomes less scarce and more easily accessible, or it can be substituted for a broader range of comparable alternatives, the value of that good decreases. A positive ‘wealth’ component (see box 1) will mean future goods are discounted more heavily, reflecting the reduced welfare we derive from consuming goods in a wealthier future.
These arguments may not hold for environmental goods, however. As society becomes richer and economic growth continues, we cannot purchase more environmental goods since they do not become more readily available over time. In fact, it has been argued that economic growth may cause a depletion in environmental resources, meaning increased wealth may actually increase the value we place on environmental goods. For example, as a country’s economy grows, there may be pressure to expand deforestation to support certain industries, thereby raising the value we place on increasingly scarce forests. Furthermore, we are unable to substitute environmental goods for other consumption goods, meaning environmental goods are not devalued in the same way.
In other terms, a scarce pool of environmental goods is our only source of environmental value, irrespective of society’s wealth levels. If we want to maximise the welfare of decision-making, we should not apply a positive ‘wealth’ component when discounting environmental benefits.
Guiding HTA
A similar rationale can be applied within health economics, where the consumption value we place on health can be argued to grow over time for two main reasons:
- As we become wealthier, the health of the population is expected to grow more slowly than the consumption of goods and services, so the value we place on health will increase relative to consumption. This argument also recognises there are limitations to substituting consumption goods for health.
- Empirical evidence exists that individuals value health more as they become richer.
The immediate policy conclusion that arises is that differential discounting should occur, with health discounted at a lower rate than costs, as the value we place on health is expected to grow. Yet, Claxton et al. (2010) explain that health benefits should only be discounted at a lower rate under certain conditions, including the expectation that the cost-effectiveness threshold (CET), or opportunity cost of healthcare spending, grows over time. NICE justifies common discounting rates by assuming that their CET is not growing over time.
In contrast, the Netherlands are one of few countries that employ differential discounting for costs and health effects, discounting costs at 4% and effects at 1.5% to reflect growth in the consumption value of health. However, the difference between rates implies an unrealistically high rate of opportunity cost growth, an issue that is due to be addressed by reducing the rate for costs to 3% in an update of guidelines in 2024.
Regardless of the approach to differential/common discounting, by accounting for growth in the value society places on health and consequently lowering discount rates for health effects, we can give more weight to future health benefits and prevent ATMPs from being unfairly disadvantaged. NICE admits the evidence suggests the case for such a change but refers to practical challenges as potential barriers to enactment.
#2 – We might want to revisit the argument against declining discount rates.
Another option that has been employed when assessing environmental policies is a discount rate that declines over the time horizon of a project, known as a declining discount rate (DDR). For example, the UK Green Book recommends a DDR, where the standard rate falls to 3.00% after 30 years and 2.50% after 75 years (see Figure 3). This DDR structure is based on work by Weitzman (2001), who proves that uncertainty and persistence in the private sector interest rate lead to DDRs.
DDRs are particularly relevant for projects that have long-term time horizons. Incorporating discount rate uncertainty through DDRs has been shown to significantly affect the present value of climate change mitigation benefits.
Figure 3 Green book long term discount rates
Guiding HTA
Within a health economics context, NICE’s 2020 discounting review did not dispute the basis for DDRs but instead reasoned that the effect of a change in line with the UK treasury’s DDR would be extremely small and add additional complexity to evaluations for minimal benefit. This assertion is based on analyses exploring DDRs in the context of vaccinations or CAR-T cell therapy, and may be outdated owing to the increase in the availability of gene therapies.
Furthermore, Weitzman’s approach has been criticised for its lack of connection to the theory of cost-benefit analysis and the incorrect assumption about the permanency of a shock to interest rates. Instead, considering uncertainty in the growth rate of consumption in an approach called the extended Ramsey Rule has been argued to be more appropriate. This may imply more rapidly declining rates depending on the level of uncertainty employed. Haute Authorite Sante in France employs a lower discount rate after 30 years, declining from 4% to 2%, approximating an extended Ramsey formula.
The appropriateness of DDR structures currently implemented in public policy requires reassessment. Work to analyse the impact of any re-estimation on the cost-effectiveness of ATMPs, particularly gene therapies, should then be undertaken to ensure we are not mistakenly disadvantaging ATMPs via the use of inappropriate DDR structures.
#3 – We should interrogate the ethical basis for discounting.
The above arguments involve technical rationale for changing discount policy, but discounting is also rooted in certain ethical assumptions rendered inappropriate in the context of climate change. When a positive, pure time preference component is included within SDRs, it implies we prioritise the welfare of current generations over the welfare of future ones since policies with benefits that fall further into the future will have their benefits more heavily discounted (see Box 1). Stern (2006) proposes a strong ethical argument against this:
Whilst ethical arguments that counter Stern’s assertions exist, a zero rate of pure time preference has been implemented in certain circumstances. The Green Book recommends this in sensitivity analyses in cases where the effects under examination are very long-term and involve irreversible wealth transfers between generations (see Figure 3). This is particularly relevant in climate change, where policy benefits may not be felt for many generations.
Guiding HTA
The intergenerational argument may hold for interventions that confer herd protection across generations, but is naturally less applicable for ATMPs because the majority of relevant interventions apply to a single individual rather than across generations. Despite this, an ethically ambiguous prioritisation of certain groups through the application of a pure rate of time preference remains, namely, the preference for those treated by interventions with short-term benefits.
Moreover, in the UK, the 0.5% rate of pure time preference is based on ‘individual time preferences for consumption’, reflecting the preferences that a given individual has over their own consumption at different points in time, termed intrapersonal time preferences. Intrapersonal preferences tend to favour the present over the future – people prefer their own consumption to happen now rather than in many years. When a social or interpersonal perspective is taken, applying these same weights has been argued to be inappropriate. There is an ongoing debate about whether pure time preference should be considered at all in the for decisions regarding public expenditure.
So, is changing the discount rate the way forward?
We have discussed potential policy options for HTA to implement that are rooted in debates about how discounting should be conducted in the face of climate change. These options should not necessarily be applied only to ATMPs but could, in theory, form part of reference-case discounting (e.g., removal of the wealth effect, declining discount rates, zero rates of time preference). This would avoid issues related to the arbitrary selection of interventions eligible for non-reference case discounting.
However, the options outlined above are associated with practical challenges. Policy changes should, therefore, not be limited to adjustments in the discount rate, with other solutions offering an alternative path forward. Evidence should be generated regarding societal preferences for one-time therapies offering curative or preventative benefits, as opposed to long-term symptomatic treatments. The results should inform the application of QALY or threshold modifiers that appropriately value the relevant therapies, many of which will be ATMPs. In addition, innovative payment models could further address uncertainties, and offer another potential avenue towards optimizing access to ATMPs.
What change the future might bring is yet to be seen. If innovative preventative and curative treatments are to be part of it, we must start shaping the related HTA context soon.
This blog, Looking further afield – What can health economics learn from the environmental economics approach to discounting?’ was commissioned by Janssen: Pharmaceutical Companies of Johnson & Johnson.
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