Working papers in cost-benefit analysis



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Working papers

in cost-benefit analysis


Office of Best Practice Regulation
Department of Finance and Deregulation

Establishing a Monetary Value for Lives Saved: Issues and Controversies

Dr Peter Abelson

WP 2008-02









Establishing a Monetary Value for Lives Saved: Issues and Controversies*1


Dr Peter Abelson
Applied Economics and

Department of Economics, Sydney University


Abstract


In Australia we spend about one-sixth of GDP to protect life and health in one way or another. This is a substantial diversion of resources away from other goods. Accordingly we would like to know whether this level of expenditure on health and safety is appropriate or whether it is too large or small. To assess such issues, quantitative measures of the value of life and health, and of safety, are needed. However most public agencies in Australia (as in most other countries) have only qualitative views about these values. This paper reviews the relevant key concepts and valuation principles based on what individuals are willing to pay for health and safety. It then describes the major methods of valuation and empirical results for values of life, health and safety. Finally it suggests possible values for saving life and increasing longevity for public policy purposes in Australia and discusses some applications. However there are some unresolved issues for which further analysis would be desirable.

Introduction


Most societies devote a large amount of resources to protecting life and health. In Australia the health care sector alone accounts for over 9 per cent of GDP. Safety expenditures in homes and the workplace, on safe products, in transport and in environmental protection account for several more percentage points of GDP. Depending on what is included as relevant expenditure, it would appear that as a nation we spend at least one dollar in six on health and safety. Add expenditure on the police and legal system and the proportion of GDP devoted to health and safety would be still higher.

Government has a major interest in this. Government is directly responsible for about 70 per cent of the health expenditures and for some of the transport expenditures. Government is also responsible for regulating workplace safety, for safe products, and for safety in transport and in the environment. Indeed ensuring the safety of the population and promoting its health are two of the prime functions of government.

But expenditure on health and safety has a cost. Therefore to make rational social choices the benefits of expenditure on health and safety should be compared with the costs, or in other words with the benefits of goods foregone. This comparison depends on the value that we attach to health and safety compared with other goods. The issue is complicated because we often spend money in both the public sphere and in markets to reduce the risk of an adverse event especially the risk of death. This introduces the valuation of probabilities into the equation. We often need estimates not only of the values of longevity and health but also of values of reductions in small risks of death.

Over the last two decades, economists around the world have devoted considerable study to the valuation of life and health and proposed many numbers. However, important issues are unresolved. They include the relationship between the value of life and the value of a life year and how the value of life may vary with age and health status. Also, as we will see, the range of possible values for life and for health states is large.

In Australia there has been relatively little analysis of these issues. Apart from some transport agencies that have developed values of life for investment appraisals, few agencies have developed values for life or health. However, the NSW Roads and Traffic Authority has commissioned a large study by PricewaterhouseCoopers (directed by Professor David Hensher) that is likely to produce recommendations shortly.

Part of the problem is political. Governments may find it hard to declare that life has some finite dollar value. And governments certainly find it hard not to rescue individuals who are known to be at risk of death whatever the expense. However, it should be possible to establish the value of a statistical life. Economists define this concept as the amount that society is willing to invest ex-ante to save the life of one person whose identity we do not know in advance.

In this paper the following section reviews the key concepts relating to health and safety and valuation principles. Sections 3 and 4 describe valuation principles and the major methods of valuation. Sections 5 describe empirical results for health and safety. Sections 6 and 7 discuss possible values for life and life years for public policy purposes in Australia and briefly discuss some applications. There is a short concluding section.

Key concepts


A key concept is the value of a statistical life (VSL). By convention this is usually assumed to be the life of a young adult with at least 40 years of life ahead. It is a statistical life because it is not the life of any particular person.

A related reason for talking about the value of a statistical life is that in many cases policies reduce the probability of death. Suppose that a policy or project reduces a small risk of fatality by one in a thousand (by 0.1 per cent). If 1000 individuals are the subject of this policy, on average the policy will save one life. This is important because what we are valuing is the reduction in a small risk for each of 1000 persons. Accordingly empirical studies need to focus on the values that individuals attach to reductions in such risks. The value of VSL will reflect these values.

For many purposes we want to know the value of a year of life because in many cases, especially in health interventions, we can save a small number of years of life rather than 40 years. However, the value of life (VSL) should presumably be related to the value of a life year (VLY).2 The higher is the value of life, the higher would be the value of a life year, and vice versa.

As observed above, VSL is often taken to be the present value of 40 life years. Most often VLY is taken to be the constant annual sum which, taken over a remaining life span, has a discounted value equal to the estimated VSL. For example, if the VSL for healthy persons with a life expectancy of 40 years is $2.5 million, applying a private time preference discount rate of 3 per cent, the value of a healthy life year would be about $108 000.

$2.5 million = $108,000 / 1.03 + $108,000 / 1.03…+ $108,000 / 1.032 40 (1)

This assumes that VLY is constant over each year. This may be a fair assumption but as discussed below VLY may vary over time. Also the result is sensitive to the choice of discount rate. VLY rises with a higher discount rate.

Conversely, estimated VLYs can be used to estimate VSLs that allow for age.

VSL(a) = VLY/(1+r) + VLY/(1+r)2 … + VLY/(1+r)n (2)

where a denotes age, n is remaining life expectancy. For example, if estimated VLY is $108 000, the current age is 65 and life expectancy is 80 years, VSL at age 65 would be $1.29 million. This implies that VSL falls steadily with age.

The value of a life year may also be described as the value of a quality adjusted life year (QALY). In the health economics literature, a QALY is a year of perfect health.

This takes us to the concept of a health state, which is also known as a quality of life (QoL) state. Typically the values of QoLs vary from 1 down to 0. Thus a QALY equals a QoL state with a value of one. On the other hand, a state of death has a value of zero. Accordingly, if someone has a QoL state equal to say 0.5, the value of a life year for that person would equal half that of a person in full health, which would be $54 000 in the above example. Improving the health status of that person from 0.5 to 1.0 would also be valued at $54 000.

Two further points about QoLs should be noted. First, to be consistent with estimated values for VSL and VLY, changes in QoLs should be based on willingness-to-pay values for health states rather than on medically determined estimates of quality of life states. Second, if the valuation methods are consistent, QoLs can be used to weight gains in life years and hence to determine gains in QALYs.


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