The Application of Cost-Benefit Analysis - Coursework Example

Cost Benefit Analysis and Value of Preventing Fatality (VPF) Name Course Name and Code Date 1.0 Introduction Sound decisions have to be made based on the underlying requirements of the different stakeholders. Numerous factors influence the decision process and also the significance of any project. However, safety and health are some of the important variables associated with the cost-benefit analysis. Cost-benefit analysis is a systematic approach that is used to estimate the weaknesses and strengths of alternatives that satisfy functional, activities or transactions requirements of business. Numerous components are used in determining costs and benefits and include cost savings, time, and labor. However, the extent of application fluctuates based on situation and requirements of the analysis. Nevertheless, cost-benefit analysis is an approach which is used to compare the benefits and costs of a project and usually influence policy direction. The purpose of cost-benefit analysis includes providing a basis for projects comparison and justifying investments. The analysis is possible through comparing the expected benefits and cost of the project and uses the methodology to determine the most appropriate approach. The aspect of benefit, further, introduces the value of preventing a fatality. The aim of the paper is to discuss cost-benefit analysis and value of preventing a fatality. 2.0 Cost Benefit Analysis In a cost-benefit analysis, the costs and benefits are grouped based on the same unit of measurement, and commonly monetary value is used, to enable effective comparison resulting in effective analysis of the different options. According to Reynolds et al. (2011) cost-benefit analysis (CBA) is a methodology that is used to value costs and benefits that enable comparison resulting in a reduction of risks associated with the safety on a consistent basis while also defining the decision making an approach. The purpose of CBA is to create a mechanism for reducing risks ‘so far as is reasonably practicable’ (SFAIRP). However, CBA is not the only methodology or determinant used in SFAIRP. Furthermore, CBA should not be used to remove the current good practice or control measures. Hence, numerous justifications are required before making a judgment. In making decisions on the adjustment of judgments, attentions should be concentrated on certain sections. Elsler et al. (2010) present the attention should be applied to the potential safety consequences and uncertainty in safety benefits and assessment of costs. Furthermore, reliance on commercial benefits to result in small safety benefits is no allowed. Nevertheless, the decision taken should be targeted to schemes resulting in reasonably practicable modifications contributing to the improvement of safety. 2.1 What is the cost? The CBA costs are the net costs that the duty holder of the program/project benefits; for example, the cost of introducing a given safety measure. The costs directly associated with safety measure that us being assessed should only be included in the analysis. The costs include any additional maintenance, training, operation, installation and other indirect costs that result because of suspension of a given service. Jallon, Imbeau and de Marcellis-Warin (2011) post, the cost that the duty holder incurs should be included in the analysis but not costs incurred by other stakeholders such as the public. Nevertheless, the costs of mitigation measures; for instance, compensation should be included in the analysis. Other costs that should not be included are the use of alternative means to address inconveniences caused. For example, if it is a railway project, the cost of using a motor vehicle for transportation purpose should not be included; other costs including ongoing revenue loss and allowance for optimism bias. In creating programs or projects, chances of savings exist, and the savings should be used to offset the identified costs (Wegman, Zhang, and Dijkstra, 2012). For example, the allocation of compensation may not be used meaning that the value of compensation should be offset. These should not be seen as safety benefits rather the reduction of overall cost of introducing and implementing the measure. Compensation and allocation for funds to other scenarios is important which aims at addressing uncertainty, and if the funds are not used, it should be deducted from the costs of the project or program (Freeman III, Herriges, and Kling, 2014). In costing on revenue losses, the duty holder is supposed to indicate the decision of implementing a measure, or scheduling the work or phasing the work to coincide with planned closures (Schousboe et al., 2011). The decision should be based on the measures and preplanned development of the project. For example, maintenance is common in numerous projects and to prevent revenue loss, closure or related decisional measure should be aligned with the period. The purpose of implementing alternative measure is to capitalize the benefit of the project through reducing the costs and avoiding wastages. The effectiveness of the approach is premised on understanding the cost of the project and alternative approaches, which can be used to address the cost complications. In addition, costing is important, and conversion of costs into monetary values is important because it is easier to use and easiness of availability of comparable data. However, the effectiveness of the conversion should be premised on the numerous regions, and these reasons should be justified as appropriate. A decision on costs and conversion should not be taken blindly, but numerous variables should be integrated into the process (Merkhofer, 2012). The analyzer may even decide to use alternative measure rather than the monetary values to ensure the appropriate outcome of the costing is known. 2.2 What is benefit The benefits incorporated into the CBA should include benefits in terms of improved safety and health. The benefits differ based on the requirements of the program and targeted stakeholders (Freeman III, Herriges, and Kling, 2014). For example, in the case of railway development, the risk reduction to members of the public, workers and passengers can be seen as among the benefits. Categorically, those benefits that targets safety and health should be included and termed as the benefits of the project. Identification of risks and quantification of risks are a problem, but an appropriate risk model should be employed. In certain scenarios, it becomes difficult to quantify some of the risks, and alternative techniques may be employed (Reynolds et al., 2011). For example, using qualitative techniques e.g. the structured workshop assessment can be used to accomplish quantification requirements. However, the effectiveness of the approach is premised on the use of expert judgment. The benefits should also be viewed from the wider context of the economy and society (Wegman, Zhang, and Dijkstra, 2012). The targeted outcome of a project may be safety and health, but the economic and social aspect may influence the effectiveness of the project. The effectiveness of the project is based on the benefits and weighing the benefits against other determinants provides a clear picture of the project. 2.3 Addressing Cost Benefit Analysis The cost-benefit analysis methodology is employed by numerous organizations and government institution. These institutions use the cost benefits analysis to appraise the possibility of the effectiveness of policy (Schousboe et al., 2011). The cost benefits analysis incorporates numerous variables such as costs and benefits while others are status quo and foregone alternatives. The use of CBA helps in predicting the benefits and determination of the extent the costs are overweighed and to what extent compared with other alternatives (Merkhofer, 2012). In a general perspective, the use of CBA is targeted on increasing the welfare of the policy. The CBA can be used to analyze different scenarios, but the user should understand that CBA should not be used exclusively in addressing social welfare and economic efficiency. In the use of CBA, numerous processes and steps are involved. The first step is listing alternative programs or projects. It is followed by listing stakeholders and selecting the elements to be measured based on the benefit and costs. The user is supposed to predict the outcome of the benefits and costs over a specified period. The variables, benefits, and costs are converted into a common currency (Schousboe et al., 2011). The user then applies the discount rate, calculates net present value of the programs, performs sensitivity analysis, and adopting the recommended choice. Even though using CBA involves numerous processes, the effectiveness is based on the program and considering whether there are other methodologies, which can be used to complement the CBA. The purpose of CBA is to measure the negative and positive consequences of a program or project. The consequences include social benefits (option value), externality effects, effects on non-participants or non-users and effects on participants or users. In a cost-benefit analysis, the financial costs are commonly used because of the voluminous market data. The benefits of a project or program may include the cost savings (willingness to pay compensation) or willingness to accept compensation for the welfare that occurs due to the policy change (Elsler et al., 2010). The appropriate strategies for evaluating the benefits is listing all the stakeholders that the intervention program effects and add the (negative and positive) value, which should be in comparable measurements, that defines its effects on the welfare (Merkhofer, 2012). The developers of the program and analyzers of the cost-benefit analysis should collect information either through revealed preference techniques or stated preference techniques to estimate the policy compensation (Schousboe et al., 2011). However, both approaches have different shortcomings regarding the collection of appropriate data. For example, the revealed preference technique may use information that is non-market welfare impacts while the stated preference techniques may misreport true preferences. A CBA analyzer should understand these challenges and create mechanisms to address these challenges during the analyzing period. Controversies are inherent in any strategic program and valuing human life is a major issue when it comes to CBA; e.g. when assessing life saving medicines or road safety measures (Merkhofer, 2012). It can be avoided by utilization of related techniques of cost-utility analysis, which expresses benefits in non-monetary units; for example, through the quality adjusted life years. For instance, in the case of road safety, the measurement can be based on cost per life saved without incorporating a financial value on the life. However, utilization of metrics that do not have monetary value creates additional challenges in evaluating certain programs (Reynolds et al., 2011). In addition, other benefits may not be substantiated meaning accruals will available, and the actual benefit of the program would not be understood. In assessing the environment value, challenges exist, but the use of valuing the services to the humans may be employed; for example, water and air quality, and pollution. The financial value can be used to other intangible effects e.g. long term strategy, market penetration and business reputation. Time and discounting are some of the important components in analyzing and using CBA. The approach that CBA employs is putting together the relevant benefits and costs are brought together through the use of time value of money technique. A discount rate is used to calculate the present value through converting future expected benefits and cost. Numerous technical framework and empirical studies indicate that people employ the discounting strategy to understand and appreciate the future. However, determination of the appropriate discount rate is usually subjective (Reynolds et al., 2011). A smaller or larger rate values depend on the requirements and expectations of humans, and it is frequently attributed to time inconsistency. The choice of rate values makes a large difference when it comes to interventions that have a long term effect. An example is the equity premium puzzle that may overestimate the benefits. Hence, due to the inconsistencies, the market rates, and approach should not be used in determining the monetary value for the future. Risk and uncertainty are another important component in CBA. Risks are inherent in any project and handling is usually based on the use of probability theory. The risk may be factored during the discounting, but the factor sometimes may be considered separately. Consideration is usually given to risk evasion in which loss avoidance is targeted overachieving gain. However, the expected return does not incorporate uncertainty detrimental effect (Pyenson et al., 2012). Alternatively, Monte Carlo simulations and sensitivity analysis can be used to complement and strengthen the outcome of the CBA. Therefore, risk and uncertainty are unavoidable, and the appropriate measure is approaching the issue from diverse perspectives with defined objectives. 3.0 Value of Preventing Fatality (VPF) The value of preventing a fatality also referred to as a value of a statistical life is a technical phrase used in safety related decision making. It is directly associated with cost-benefit analysis (Reynolds et al., 2011). The decision to improve the safety measure to reduce chances of risk that may result in death is questionable and may be associated with numerous components including the social and economic components. In certain instances, the cost of saving a life is higher or expensive, a review and criterion should be employed in determining the future of the strategy. In determining the appropriateness of the decision, numerous factors have to be considered include the cost of the project, the expected number of lives to be saved and the value of preventing a fatality based on regulations. Numerous stakeholders think that the use of CBA is inappropriate in making safety and health decisions because of placing a value on human lives (Elsler et al., 2010). However, arguments exist to the contrary. The value assigned is not the value of human beings rather an amount that should be invested in championing safety and health requirements. Therefore, VPF should not be confused with the manner in which courts and the society assign a given compensation to a real person. Consumer behavior influences the compensation and tradeoffs. For example, declining to purchase or purchasing a small device to champion safety is within the consumer decision making or even acquiring a smoke alarm is a trade off against alternatives (Pyenson et al., 2012). It is imperative to note that the concept of saving a life is different compared to saving a particular identified individual (Merkhofer, 2012). Cases such as saving a known individual, such as sailors in a stricken ship or trapped miners are rarely documented or discussed. A statistical life is different from the examples because it is premised on mitigations obtained from low probability risks, which can be compared with the ordinary economic transaction. Apart from saving an identified person and saving a statistical life, the third category of anonymous life should be incorporated into the analysis. The statistical analysis of the occurrence of death requires further distinction. The first problem is there are differences between situations, and if similar occurrences had occurred in the future, the statistical component cannot suffice. In allocating costs to statistical life, intuition plays an important role. For example, the policy employed in addressing nuclear safety and road safety is completely different because of the outcome of an accident (Pyenson et al., 2012). For example, should the analyzer be more conscious when it comes to nuclear related safety compared with road accidents since the impact of life can be debated or frequency of occurrence of the problem (Wegman, Zhang, and Dijkstra, 2012). The value of statistical life has been discussed extensively, and it has been viewed from angles of investment, but the approach is unsatisfactory (Schousboe et al., 2011). One of the problems is the peculiarity of the calculations because of instances of negative results. Another issue is the reduction of a small risk of a larger population and the consequences of saving a given life. Even an individual who is old and does not have an economic benefit to the society, the individual may be ready to invest to reduce a small risk to enable the individual to continue living appropriately (Pyenson et al., 2012). Reducing chances of death to the elderly individual is appropriate even though the cost of healthcare, for example, is higher. Therefore, quantifying and allocating the value of statistical life creates challenges based on the context and situation. Understanding that the value of preventing a fatality can be viewed or rated in terms of risk reduction rather than aiming to save a life, a realization occurs in which reduction of a small risk is seen as an ordinary commercial translation, and can encourage the introduction of alternative value analysis methodologies. Both actual market behavior valuation and contingent valuation are used in determining the preference of paying. The payment is aimed at reducing the risks and saving a life. The effectiveness of the evaluation strategies can be questioned based on the circumstances and views of the stakeholders involved in the entire process (Elsler et al., 2010). The behavior valuation utilizes the underlying attitudes of an individual based on the daily decision making proves. In addition, the use of contingent valuation creates additional challenges because of high uncertainty and availability of comparative data (Wegman, Zhang, and Dijkstra, 2012). It creates a challenge to the analyzer and determining the most appropriate strategy is left to the market dynamics, context and situations. The utilization of value of preventing a fatality has been critiqued from policy making perspective. Two common examples exist of age and economic position of the population (Reynolds et al., 2011). For example, VPF can be adjusted based on age, but the elderly or young persons have a given value whether the economic or societal value. In addition, aligning VPF with economic disposition is sometimes questionable. For example, people from poor communications are allowed a weaker VPF compared with individuals from advanced societies. Another important issue is regulatory failures and characterizing market. The VPF is assumed in a well functioning environment, but failures are sometimes inevitable (Schousboe et al., 2011). Numerous market failures and regulatory failures exist, and the appropriate strategy is the identification of these challenges (Shrader-Frechette, 2012). For example, complaints have been presented in working conditions due to high job hazards, but the effectiveness of safety and health are still questionable. The high rates of accidents and regulatory failure in heavily regulated working environments illustrates the challenges that VPF has to address. Implementation of VPF from a collective perspective has to incorporate the regulatory challenges and characterization of the market. Numerous examples of VPF exist especially in the tobacco industry (Wegman, Zhang, and Dijkstra, 2012). Externalizations such as passive smoking and social costs of health expenditures cannot justify the high taxation on the cigarettes tax. The higher requirement of smokers to the pension scheme and the same smokers’ life expectancy is lower by six years (Schousboe et al., 2011). Regressive taxation and approaches that affects the lower income earners compared with, the higher income earners illustrates the provocative nature of the use of VPF in determining costs and benefits. It is correct to state that smoking affects the development and economic capacities of an individual but punishing individual consuming these “dangerous” products is inappropriate. The solution is not using the skewed legislations and directions, rather the actual costs and benefits of the entire process should be analyzed. These processes would ensure the actual nature of cost and benefit reflects on the circumstances surrounding VPF. 4.0 Conclusion In conclusion, analyzing risks is important, and methodologies should exist that elaborates on the issue. One of the methodologies is the cost benefits analysis. The analysis brings together the cost of the project or program and expected benefits. These are weighted together through giving a negative and a positive denotation, and the final value is obtained through addition of the variables. The cost and benefits have to be presented in monetary measures since it is easier to use; however, alternative mechanisms may be employed to advance the requirements of understanding the cost and the outcome. In addressing the cost-benefit analysis, the value of preventing fatality is also important. The value is based on the risks and the cost of reduction of the risks; even though debates exist on the extent of use of the value of preventing a fatality. Some of the controversies include assigning a monetary value to the lives of people. Nevertheless, the analyzer or user of the techniques should complement the CBA with other methodologies to strengthen or improve the credibility of the program or intervention. References Elsler, D., Treutlein, D., Rydlewska, I., Frusteri, L., Krüger, H., Veerman, T., Eeckelaert, L., Roskams, N., Van Den Broek, K. and Taylor, T.N., 2010. A review of case studies evaluating economic incentives to promote occupational safety and health. Scandinavian Journal of Work, Environment & Health, pp. 289-298. Freeman III, A.M., Herriges, J.A. and Kling, C.L., 2014. The measurement of environmental and resource values: theory and methods. Routledge. Jallon, R., Imbeau, D. and de Marcellis-Warin, N., 2011. Development of an indirect-cost calculation model suitable for workplace use. Journal of Safety Research, 42(3), pp. 149-164. Merkhofer, M.W., 2012. Decision Science and Social Risk Management: A Comparative Evaluation of cost-benefit analysis, decision analysis, and other formal decision-aiding approaches (Vol. 2). Springer Science & Business Media. Pyenson, B.S., Sander, M.S., Jiang, Y., Kahn, H. and Mulshine, J.L., 2012. An actuarial analysis shows that offering lung cancer screening as an insurance benefit would save lives at relatively low cost. Health Affairs, 31(4), pp. 770-779. Reynolds, A.J., Temple, J.A., White, B.A., Ou, S.R. and Robertson, D.L., 2011. Age 26 cost–benefit analysis of the child‐parent center early education program. Child Development, 82(1), pp. 379-404. Schousboe, J.T., Kerlikowske, K., Loh, A. and Cummings, S.R., 2011. Personalizing mammography by breast density and other risk factors for breast cancer: analysis of health benefits and cost-effectiveness. Annals of Internal Medicine, 155(1), pp. 10-20. Shrader-Frechette, K., 2012. Risk analysis and scientific method: Methodological and ethical problems with evaluating societal hazards. Springer Science & Business Media. Wegman, F., Zhang, F. and Dijkstra, A., 2012. How to make more cycling good for road safety?. Accident Analysis & Prevention, 44(1), pp.19-29. Read More