On Moral Hazard in Health Insurance

As we look ahead to  tonight’s  State of the Union address, I.I.I. chief actuary Jim Lynch brings us a book review on the perennial issue of health insurance:

When Target wants to sell more shirts, it puts them on sale. The retailer knows that the less something costs, the more likely you are to buy it.

Health care is more complicated, in no small part because the customer is buying something he or she would rather not need. If your doctor halved the fee for open-heart surgery, for example, you wouldn’t submit to it twice.

For other procedures, the situation is murkier. Most people would submit to an extra blood stick to ensure they were disease-free, particularly if somebody else (read: the insurance company) paid the bill.

To an economist, the possibility that consumers run up a tab on health insurers is a moral hazard. Another moral hazard is the tendency of insured people to smoke and eat more, because someone else will pay for the resulting maladies. Both were an important points in Moral Hazard in Health Insurance, a book culled from lectures at Columbia University in 2012. I reviewed the book in the latest issue of Contingencies, the magazine of the American Academy of Actuaries.

The main lecture, by respected MIT economist Amy Finkelstein, dissected a natural experiment that resulted from a funding shortage in Oregon. The state only had enough money to put 10,000 people on Medicaid, but it had far more people who qualified for the program.

The state held a lottery. Some people held the metaphorical winning tickets, and they got health insurance. The rest did not.

Though potentially tragic for the losers, the lottery created something social scientists like, a randomized sample that let them study how the behaviors of the insured and uninsured differ in the real world. They found that the insured did indeed consume more health care than the uninsured.

This finding is important because it supports ideas long held in the insurance world that higher deductibles and other forms of cost sharing reduce losses by giving all participants “skin in the game.”

My review also noted that some medical professionals participate in their own variety of moral hazard.

To find out more about health insurance, check out this Facts and Stats item at the I.I.I. website.

One thought on “On Moral Hazard in Health Insurance”

  1. The book sounds like an interesting read. I just have two thoughts, one about each type of moral hazard.

    I think the concept of ex ante moral hazard ignores a basic truth, which is that getting sick is unpleasant. I don’t smoke, but I do eat more cookies than I should. The decision to smoke or not smoke, or the decision to eat or not eat a chocolate chunk cookie, centers around the perceived pleasure from the experience. I don’t smoke because I fear getting cancer or heart disease. Other people smoke because of the way it makes them feel. They know smoking may be bad for their health, but the instant pleasurable experience overrides that knowledge. Same with me and the chocolate chunk cookie. I know that extra pounds are bad for me, but the pleasure from eating the cookie overrides it. My point is that people tend to focus on the benefit vs. cost of smoking the cigarette or eating the cookie. I believe their health insurance coverage barely registers in the decision-making process. Later, if they become ill, their focus is on pain relief, not on insurance coverage.

    Regarding ex post moral hazard, the idea of giving consumers “skin in the game” is unworkable so long as consumers do not know the price of a procedure before they buy it. I wrote about my personal experience with this at http://insurancegeek.typepad.com/ask_tim/2012/09/how-much-cost.html.

    Thank you, Jim, for an informative review of the book.

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