Cost‐effectiveness analysis with risk aversion

AbstractThis paper discusses why, in a medical context, the standard assumption of a risk‐neutral social planner is inappropriate and develops a framework for conducting cost‐effectiveness (CE) analysis when social planners are risk‐averse. This framework demonstrates that if new medical interventions are variance increasing (decreasing), the risk‐neutral approach will approve (reject) projects that should be rejected (accepted). This methodology is applied to two medical interventions that have been previously evaluated and considered cost‐effective in the published literature. Since both conclusions assumed risk neutrality we determine the level of societal risk‐aversion that would be necessary to reject these new interventions and compare these levels to previous estimates of risk‐aversion in the economics literature. We find that for reasonable values of the risk‐aversion parameter, only one of the two interventions should be approved. It is our recommendation that the cut‐off risk aversion parameter (the level of risk‐aversion above which a project would be rejected) should become a standard reported figure in future CE studies. Copyright © 2001 John Wiley & Sons, Ltd.