Amy Finkelstein: Moral Hazard in Health Insurance

Columbia University Press
December 2014
Moral Hazard in Health Insurance
By Amy Finkelstein

In 1963, Ken Arrow proposed the concept of moral hazard in health
insurance, the idea that health insurance may increase the demand for
medical care. That creates a fundamental tension for health policy that
is trying both to cover the uninsured and simultaneously reduce the
level and growth of health spending.

The challenge posed in Arrow's paper to subsequent generations of
economists was whether we could verify that this theoretical notion of
moral hazard and health insurance actually existed, and whether we could
quantify its magnitude and explore its nature and implications.

How have we risen to this challenge? There is compelling evidence from
randomized trials that health insurance affects medical spending. Those
who say otherwise are ignoring the evidence at their own peril. This is
a fact of life. It mat not be what we wished for, but we have to think
about it, grapple with it, and think about its implications for policy.

http://cup.columbia.edu/book/moral-hazard-in-health-insurance/9780231163804

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Journal of Economic Perspectives
Winter 2013
The RAND Health Insurance Experiment, Three Decades Later
By Aviva Aron-Dine, Liran Einav, and Amy Finkelstein

Our reexamination concludes that despite the potential for substantial
bias in the original estimates stemming from systematically differential
participation and reporting across experimental arms, one of the central
contributions of the RAND experiment is robust: the rejection of the
null hypothesis that health spending does not respond to the
out-of-pocket price. Naturally, however, these potential biases
introduce uncertainty about the magnitude of the impact of the different
insurance plans on medical spending. Moreover, the translation of these
experimental estimates into economic objects of interest—such as a price
elasticity of demand for medical care—requires further assumptions and
machinery, which go beyond the "raw" experimental results. While
economic analysis has made progress in the intervening decades in
developing techniques that may offer new approaches to the economic
analysis of moral hazard effects of health insurance, it will always be
the case that, like the famous –0.2 price elasticity of demand estimate
produced by the original RAND investigators, any attempt by researchers
to apply the experimental estimates out of sample will involve more
assumptions—and hence scope for uncertainty—than the direct experimental
estimates themselves. This point, while straightforward and
uncontroversial (we'd think), may have become somewhat lost in the
intervening decades of use of the RAND estimates. Our hope is that this
essay may help put both the famous experiment and its results back in
context.

http://economics.mit.edu/files/8400

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Comment by Don McCanne

This short book by Amy Finkelstein, "Moral Hazard in Health Insurance,"
provides an excellent update that can be used to better understand the
application of the concept of moral hazard to the design of health care
financing. But more must be said.

The book is based on the fifth annual Kenneth J. Arrow Lecture presented
at Columbia University in April 2012. Finkelstein's lecture is covered
in 30 pages. An introduction is provided by Joseph P. Newhouse (RAND
HIE). Commentaries are provided by Jonathan Gruber (provider-side moral
hazard), Kenneth J. Arrow himself (asymmetry of information), Joseph E.
Stiglitz (markets and health care), and a brief discussion follows.
Finally, Kenneth Arrow's seminal 1963 paper, "Uncertainty and the
Welfare Economics of Medical Care," is included. This book should be in
every library covering health policy.

As applied to health insurance, the concept of moral hazard is quite
simple: many people will use more health care if they are protected from
the out-of-pocket costs of that care. What is not so simple is how much
of an impact that has and what the ramifications are. Amy Finkelstien
helps us by explaining that there is much unknown, and that even the
classical studies must be interpreted with great care as they are
applied to today's insurance models. Nevertheless, she makes the case
that the evidence that health insurance affects medical spending is
compelling.

One important concern about her presentation is that she attacks what
she calls "the rhetorical case against the notion of moral hazard and
health insurance" by criticizing the "alternative view" that "medical
care is determined not by price but by needs." She then seems to dismiss
the great work by John Nyman plus the input by Uwe Reinhardt, not
directly, but by merely including them in a quote from Malcolm
Gladwell's New Yorker article, "The Moral-Hazard Myth." When she writes,
"Those who say otherwise are ignoring the evidence at their own peril,"
it seems that she is referring to Gladwell, Nyman and Reinhardt.

Unfortunately, she seems to be guilty of using a straw man analogy. I do
not recall ever reading that either Nyman or Reinhardt said that price
was not a factor in medical care. In fact, Reinhardt is coauthor of the
Health Affairs article, "It's the Prices, Stupid." However, they have
both made the point that need is a very important factor in accessing
medical care, even when there are price barriers. Moral hazard
enthusiasts need to address medical need.

The greatest problem with this book is that it advances, without
requisite criticism, the widely accepted thesis that having insurance
increases health care spending . This concept has resulted in the
widespread application of countermeasures that erect financial barriers
to care - high deductibles, greater coinsurance, tiering of benefits,
and narrow networks. All of these impair patient access to beneficial
care - the opposite of what a well-functioning system should be
providing for us.

Is depriving patients of beneficial care harmful? Many economists seem
to glibly dismiss the potential harm if it is effective in reducing
spending. They cite the RAND HIE and the Oregon natural experiment as
showing that harm is negligible or non-existent. Yet Finkelstein and her
colleagues, in the Journal of Economic Perspectives paper on the RAND
HIE, state, "attempt by researchers to apply the experimental estimates
out of sample will involve more assumptions - and hence scope for
uncertainty - than the direct experimental estimates themselves."

It is frequently stated in the lay literature that the RAND HIE and the
Oregon experiment showed that the decrease in care caused by patient
out-of-pocket spending does not result in adverse outcomes. That
statement is incorrect. There were some adverse outcomes in both
studies, but, more importantly, the studies concentrated on spending and
were not powered to detect impaired health outcomes. The facts are that
we do not have studies that can reliably assure us that no harm is done.
Such studies would be complex, expensive and unethical.

We have a century of experience with our health care delivery system.
The beneficial effects of modern health care far outweigh the
detrimental effects. We do not need policy studies to try to counter
this observation. It is intuitive that having better access to health
care is beneficial, and, in this case, intuition is more than enough to
drive policy.

From the perspective of optimal patient care, the thesis of this book
is upside-down. Rather than looking at the increase in spending that
occurs when a person is covered with insurance, we should be looking at
the impaired access that results from the reduction in spending due to
ill-advised financial barriers erected through insurance innovations.
Our efforts should be directed toward removing those barriers.

But then what about the spending that economists characterize as
"increases" due to moral hazard? The answer is simple. Instead of
depriving patients of beneficial care we should turn to the other
methods of containing costs that have been proven to be effective in
other nations.

We could start with the administrative waste that would be recovered
simply by converting to a single payer system (not to mention the many
other financial benefits of single payer). Just the administrative
savings alone would be far more than could ever be saved through the
application of moral hazard policies.

We already have high deductibles and coinsurance, and yet our health
care costs are much higher than in those nations that do not use such
detrimental interventions. Application of moral hazard theory has been a
failure primarily because it diverted our attention away from social
policies that would advance health care justice.