Health Economics Fundamentals

Health economics is the discipline that provides payers and health technology assessment bodies with the analytical framework to decide whether a new product or intervention is worth paying for. It is not a soft science of preferences and opinions. It produces quantitative models with specific inputs, specific outputs, and reviewable assumptions. Founders who do not understand how these models work cannot effectively challenge the assumptions payers use against them, and cannot credibly present economic evidence in their favor.

The quality-adjusted life year, or QALY, is the primary unit of health outcome in most economic evaluations conducted outside the United States, and increasingly within it. One QALY represents one year of life lived in perfect health. A year lived in a health state with diminished quality — due to pain, disability, or functional limitation — is worth less than one QALY. The utility weight assigned to any given health state falls between 0 (equivalent to death) and 1 (perfect health). These utility weights are measured through patient surveys and validated instruments, and they are contested. The assumption that a year with moderate chronic pain has a utility of 0.72 is a modeling choice that will determine whether your product clears the cost-effectiveness threshold.

Cost-effectiveness analysis, or CEA, compares the incremental cost of a new intervention against the incremental health benefit it produces relative to the current standard of care. The output is an incremental cost-effectiveness ratio, or ICER — not to be confused with the Institute for Clinical and Economic Review, which uses the same acronym. The ICER is expressed as cost per QALY gained. In the UK, the National Institute for Health and Care Excellence, or NICE, uses a threshold of approximately £20,000 to £30,000 per QALY. In the US, ICER has proposed a threshold range of $100,000 to $150,000 per QALY as a reference point, though no single US payer is legally bound by any threshold.

The perspective of the analysis is one of the most consequential modeling choices and the one most frequently glossed over in submitted economic dossiers. A societal perspective includes all costs and benefits, including those borne by patients, caregivers, and the broader economy through productivity effects. A payer perspective includes only what the payer pays and what the payer saves. A product that looks highly cost-effective from a societal perspective because it dramatically reduces workplace absenteeism may look cost-ineffective from a payer perspective because those productivity gains do not flow back to the payer's budget. Payers evaluate from their own perspective. Build your model accordingly.

Real-world evidence, or RWE, refers to clinical and economic data derived from actual patient care outside controlled trial settings — from electronic health records, insurance claims, patient registries, and wearable or sensor data. RWE has become increasingly important because randomized controlled trials, while the gold standard for clinical evidence, are expensive, take years, and enroll patient populations that may not reflect the real-world patients who will use the product. Payers increasingly require RWE to validate that trial-based efficacy translates to real-world effectiveness. The gap between efficacy (what a product does under ideal conditions) and effectiveness (what it does in routine practice) is where many coverage decisions are lost.

Health technology assessment, or HTA, is the formal process by which health systems and payers evaluate new technologies for coverage and reimbursement decisions. In the UK, NICE conducts HTA. In Germany, the Institute for Quality and Efficiency in Health Care, or IQWiG, conducts it. In the US, there is no single mandatory HTA body — the Inflation Reduction Act of 2022 introduced Medicare drug price negotiation authority, and ICER functions as an independent HTA organization whose reports payers and PBMs increasingly reference in coverage decisions. Understanding how your target market conducts HTA is not optional if you are pricing above commodity levels.

Discount rates in health economic models are not an arcane technical detail. They reflect the assumption that costs and health benefits occurring in the future are worth less than those occurring today — the same logic as net present value in finance. Standard discount rates are typically 3% to 5% per year for both costs and outcomes. A product with most of its benefit realized five or ten years from now — such as a preventive intervention — looks far less cost-effective under discounting than one with immediate benefit. This is one of the structural reasons preventive care consistently struggles to clear cost-effectiveness thresholds despite obvious long-term value.