Moral Hazard

i. There are two types of moral hazard:

1. Ex ante moral hazard is a moral hazard that changes your behavior such that the risk of some outcome is increased. Having health insurance may result in you being less careful because you are protected from the full costs of any injuries. 2. Ex post moral hazard is a moral hazard that arises after the event occurs. If you are insured and suffer an injury, you likely make greater use of your health insurance and consume more health care.

1. We could reduce the size of moral hazard by raising the cost-sharing of health insurance. The more the cost-sharing, the smaller the moral hazard.

1. However, people don't seem to be good at reducing only low value care (e.g., the type of care that comes after the optimal quantity) but instead seem to reduce highly effective and ineffective care at the same rate with cost sharing. 2. This "across the board" reduction in consumption with cost sharing may reduce welfare more than the moral hazard we are concerned with.

copayment a. causes the demand curve to become perfectly vertical where it intersects the price of the copayment

The copayment amount, which is less than the price of the good, is the solid black line. Once the demand curve intersects with the copayment amount, it becomes a vertical line. The surplus from consumption of health care is the green triangle while the welfare loss due to the moral hazard is the orange triangle. The welfare loss is given by the difference between the price curve and the uninsured demand curve, which gives us the region to shade.

The deductible is the solid black line in the graph. For prices less than the deductible, the quantity is the same with or without insurance. However, when the price is above the deductible, the demand curve rotates due to the addition of the coinsurance.

The surplus from consumption of health care is the green triangle while the welfare loss due to the moral hazard is the orange triangle. The welfare loss is given by the difference between the price curve and the uninsured demand curve, which gives us the region to shade.

The indemnity shifts the demand curve to the right or upward. The amount of the shift is determined by the amount of the indemnity. Large indemnities cause bigger shifts.

The surplus from consumption of health care is the green triangle while the welfare loss due to the moral hazard is the orange triangle. The welfare loss is given by the difference between the price curve and the uninsured demand curve, which gives us the region to shade.

a. With a coinsurance, the demand curve rotates to the right as the coinsurance gets smaller (e.g., as the insurance becomes more generous)

The surplus from consumption of health care is the region shaded in green. The welfare loss due to the moral hazard is the orange region. This is because the quantity demanded shifts out to the intersection of the new demand curve and the price curves. The welfare loss is given by the difference between the price curve and the uninsured demand curve, which gives us the region to shade.

1. copayment

a. A copayment system replaces the price a person provides for a health care good to some fixed price set by the health insurance company.

deductible

a. A deductible is an amount that a person has to pay out-of-pocket for health care before the health insurance plan makes any payments. After paying the deductible, the health insurance plan generally shifts towards a coinsurance model.

Indemnity

a. An indemnity is a fixed amount of insurance that an insurance plan pays for a claim. For instance, it might pay $75 for a clinic visit. If the clinic visit is $100, the patient pays $25 and the insurance pays $75. If it is $150, the patient pays $75 and the insurance pays $75. Regardless of what the doctor's office charges, the insurance only pays the amount of the indemnity.

1. Coinsurance

a. Coinsurance requires the person to pay a percentage of their health care spending. For instance, 20% coinsurance requires you to pay 20% of your health care bill while 10% coinsurance requires you to only pay 10%. As coinsurance gets smaller, the portion of the costs paid by the consumer gets smaller.

Moral hazard is an inescapable aspect of insurance

i. All insurance designs have the potential for moral hazard

What is Moral Hazard?

i. Moral hazard is when behavior is changed as the result of some choice because you do not bear the full costs of the behavior. For instance, buying health insurance may encourage you to take risky behaviors and also to consume more health care because the cost of those actions is distributed across all people on the health insurance plan.

a. Why does a moral hazard reduce welfare?

i. Moral hazard reduces welfare because it encourages consumption above and beyond the optimal quantity by reducing the exposure to the total cost of the consumption. Since quantity consumed is above the optimal quantity, total welfare is reduced.

Surplus

i. Surplus comes from consumption where the demand curve is above the price curve. When the demand curve is above the price curve it means consumers are willing to pay morethan the price for that quantity of goods. Since they are willing to pay more than the price they pay, they get surplus value.