The National Bureau of Economic Research
Estimating the Tradeoff Between Risk Protection and Moral Hazard with a Nonlinear Budget Set Model of Health Insurance
By Amanda E. Kowalski
Insurance induces a well-known tradeoff between the welfare gains from risk protection and the welfare losses from moral hazard. Empirical work traditionally estimates each side of the tradeoff separately, potentially yielding mutually inconsistent results. I develop a nonlinear budget set model of health insurance that allows for the calculation of both sides of the tradeoff simultaneously, allowing for a relationship between moral hazard and risk protection. An important feature of this model is that it considers nonlinearities in the consumer budget set that arise from deductibles, coinsurance rates, and stoplosses that alter moral hazard as well as risk protection relative to no insurance. I illustrate the properties of my model by estimating it using data on employer sponsored health insurance from a large firm. Within my empirical context, the average deadweight losses from moral hazard substantially outweigh the average welfare gains from risk protection. However, the welfare impact of moral hazard and risk protection are both small relative to transfers from the government through the tax preference for employer sponsored health insurance and transfers from some agents to other agents through a common premium.
4.3 The Estimated Tradeoﬀ Between Moral Hazard and Risk Protection
The third panel of Table 10 gives the tradeoﬀ between the welfare gain from risk protection and the deadweight loss from moral hazard. The distribution of the tradeoﬀ at any quantile generally is not equal to the diﬀerence between DWL (deadweight loss) and RPP (risk protection premium) at those quantiles. However, as shown in the penultimate column, the mean tradeoﬀ is equal to the mean DWL minus the mean RPP. For all oﬀered and hypothetical plans considered, the results show that the average deadweight loss exceeds the gain from risk protection. The average net welfare loss in each of the oﬀered plans is around $5, or 0.25% of money at stake.
We see that the welfare gains that we estimate from insurance in Table 11 are very similar to predicted insurer spending reported in Table 8; demographic groups with higher predicted insurer spending derive a larger welfare gain from insurance than demographic groups with lower predicted insurer spending. As we see in Table 12, demographic groups with larger predicted insurer spending also have larger deadweight losses. Risk protection does not appear to vary with predicted insurer spending because the magnitudes of the risk protection premium are so small, but there is also some variation in the risk protection premium across demographic groups.
Full paper (highly technical):
Comment: The mainstream policy community likely will take from this study the fact that it supports the prevailing notion that losses from insured patients using more health care than they otherwise would have (moral hazard) are greater than the gains in protecting personal finances in the face of medical need (risk protection). Such an interpretation would be unfortunate simply because it is inadequate and therefore misleading.
Most importantly, the net welfare loss of using more care when there is risk protection is so small that it is almost negligible. In fact, the population studied (employees of a large retail trade firm) did not have high health expenditures and therefore would be the most likely to respond to direct costs incurred below their deductibles. Yet the data show that mean value of the extra care obtained above the value of the risk protection premium was almost negligible.
Most of health care spending is incurred by those with greater health care needs, a group that was not represented in this study of healthier individuals. People with greater health care needs exceed their deductibles and consequently do not experience consumer sensitivity to most of their health care prices.
Another important issue is that the extra health care accessed as a result of moral hazard should not be automatically dismissed as excess care. Half of it is not since it includes beneficial services, even though these services risk being dismissed merely because they are not reflected in improved mortality data. Even the care that might not seem to be beneficial still provides reassurance to concerned patients that their presenting complaints do not warrant further diagnostic or therapeutic intervention. Reassurance provided by health care professionals should not be considered to be a moral hazard.
The lesson to take home from this study is that the cost of trading up for more risk protection is almost negligible when the price paid is a very small increment in additional spending on largely beneficial health care that might otherwise have been foregone.
This is crucial in the continued debate over health care reform. There is considerable political pressure to shift price sensitivity to health care consumer/patients through consumer-directed high-deductible plans, health savings accounts, vouchers for Medicare plans, lower-tier plans in insurance exchanges, and other devious innovations that insurers will no doubt introduce in the future. These concepts are to deter the false bogeyman of moral hazard, but at the profound cost of threatening financial security for those of us with health care needs.
Regular readers already know how we can circumvent this nonsense - simply enact a single payer national health program that eliminates cost sharing. Countries that spend on average only half of what we do have shown that it can be done. The moral hazard is in not doing it.