HEALTH ECONOMICS Health Econ. 7: 701–710 (1998) COSTING METHODOLOGY ESTIMATION OF A MULTIPRODUCT COST FUNCTION FOR PHYSICALLY FRAIL OLDER PEOPLE PAUL McNAMEE*, BARBARA A. GREGSON, KEN WRIGHT, DEBBIE BUCK, CLAIRE H. BAMFORD AND JOHN BOND The Resource Implications Study Group of the MRC Cognitie Function and Ageing Study, UK SUMMARY Using the theory of multiproduct cost functions, this paper derives a cost function for physically frail older people living in private households, based on data collected between 1991 and 1995, for 472 subjects aged 65 years of age or over in four areas of England. The main characteristic of the cost function is that output categories are classified in terms of movements between different health states. These were measured by changes in activities of daily living (ADL) over 2 years, with ‘low’ ADL representing better functional ability than ‘high’ ADL. Empirical application of the approach, using four states defined in terms of worsening progression (stable low ADL; deteriorated or improved ADL; stable high ADL; deceased), indicated more favourable states were associated with lower costs. Multivariate analysis showed that the derived states were significantly related to costs which, when combined with variables indicating presence of particular chronic health conditions (diabetes or previous stroke), admission to continuing care accommodation and household structure, explained one-fifth of the variation in log average costs per week. Variables such as age, sex, carer input, social networks and level of cognitive functioning had no independent impact on costs. These findings could be used as a starting point for those interested in predicting the cost implications associated with the ageing population. © 1998 John Wiley & Sons, Ltd. KEY WORDS — cost function; health states; frail older people INTRODUCTION There is widespread evidence that frail older peo- ple require substantial levels of support both from informal carers [1,2] and formal care services [3,4], with growing concern that a continued rise in the number of people above the statutory retirement age will lead to escalating costs [5]. In particular, it is widely believed that current levels of informal support are less likely to be maintained, owing to changes in support networks, demography and the rise in labour force participation among women [6]. Therefore, changes in the scale of provision within the formal sector may be re- quired to match any future increases in care needs. To plan for such changes, however, some knowledge of the relationship between different levels of physical frailty and costs is required. Previous studies have demonstrated that func- tional ability, measured by activities of daily liv- ing (ADL, [7]) is related to resource use [3,4] and costs [8]. However, these either report cross-sec- tional estimates or have used longitudinal designs that fail to examine changes in functional ability over time. Where estimates of transitions between different levels of functional ability exist [9 – 11], no attempt has been made to relate these to * Correspondence to: Department of Epidemiology and Public Health, School of Health Sciences, University of Newcastle upon Tyne, NE2 4HH, UK. Tel.: +44 191 2227027; fax: +44 191 2226746. CCC 1057–9230/98/080701 – 10$17.50 © 1998 John Wiley & Sons, Ltd. Receied 2 July 1997 Accepted 30 June 1998