The role that cost-effectiveness analysis (CEA) plays in incentivizing innovation is controversial. Detractors criticize the use of CEA for pricing purposes because it disregards the value of innovation brought by new drugs, while supporters argue that it is already accounted for. The objective of this article is to identify the limitations of the conventional CEA approach and propose an alternative that incorporates the value of innovation. The adoption of a new drug benefits all patients (present and future) with cost implications for as long the drug is part of clinical practice. Incidence population and off-patent price are identified as two key missing features preventing the conventional CEA approach from capturing: 1)benefit to future patients, and 2)future savings from off-patent prices. The proposed CEA approach incorporates these two features to derive the total lifetime value of an innovative drug (value of innovation). The conventional CEA approach tends to underestimate the value of innovative drugs as a result of disregarding the benefit to future patients and savings from off-patent prices. Consequently, innovative drugs get underpriced, only allowing manufacturers to appropriate around 15% of the total value of innovation during the patent protection period. In addition to including the benefit to future patients and savings from off-patent prices, the alternative approach proposes to first negotiate the share of value of innovation between the manufacturer and healthcare system, and then identify the drug price that satisfies this condition. The approach proposed here integrates the total lifetime value of innovative drugs into CEA (the value of innovation), and then derives the price that allows the manufacturer to appropriate the agreed share of this value. This is intended to incentivize innovation while supporting healthcare systems to pursue dynamic allocative efficiency. The long-term sustainability of healthcare systems must be investigated before this proposal is adopted by policymakers.