Moral Hazard

Describe cost-sharing insurance plans and how they limit moral hazard

Coinsurance: enrolees pay a percentage of each medical bill and insurer covers remaining portion Co-payment plan: enrolees pay a fixed amount, called a copayment, for each medical episode and insurer covers all costs above this copayment Cost-sharing means customer's wealth level will vary depending on health outcomes and by lowering price distortion, moral hazard is limited

What is monitoring and gatekeeping and how do they reduce moral hazard?

Confronts information asymmetry head on Monitoring: encouraging enrolees to exercise and stay healthy, offer annual cash payment if employees complete tasks e.g. fitness test, visit with a nutritionist, on-campus athletic class; limits ex ante moral hazard Gatekeeping: insurance-company doctor may send patient with headache away with painkillers, rather than patient seeking expensive CT scan; can substantially reduce unnecessary medical procedures; limits ex post moral hazard

What is moral hazard?

Encompasses all risky changes in behaviour resulting from insurance coverage Moral hazard & insurance: the tendency for insurance against loss to reduce incentives to prevent or minimise the cost of loss

Describe the extent of price distortion as a function of the 'completeness' of insurance

If insurance is full any health outcome will not impact individuals income thus, (financial) price of any injury or illness is zero and price distortion is large If insurance is partial, customer must pay positive amount out of pocket so medical care is not completely free. Price distortion is smaller and moral hazard is less severe

Describe the simple pattern of moral hazard

1. An individual faces some risk of a bad event, X with his actions either increasing or decreasing its likelihood 2. The individual buys an insurance contract that will help pay for some or all of the costs of X if it occurs; price of X = lower (price distortion) 3. In response to price distortion, individual changes his behaviour in a way that increases the chances of X or increases the costs of recovering from X 4. The insurance company cannot observe the behaviour change, because there is INFORMATION ASYMMETRY 5. The individual's riskier behaviour creates a social loss (because costly event, X, occurs more than it would have without insurance)

What are the 3 key factors needed for moral hazard to occur?

1. Price distortion 2. Price sensitivity 3. Asymmetric information

Describe deductibles and how they limit moral hazard

Deductibles set minimal levels of expenses below which the insurer does not help reimburse medical expenses E.g. $1,000 deductible of care Individual pays for hi first thousandth dollars of health care expenditures out-of-pocket May be paired with coinsurance or co-payments in the same policy Requires insurance enrolees to pay a deductible can limit or eliminate moral hazard from insurance

What are the two main types of moral hazard?

Ex ante: behaviour changes that occur BEFORE an insured event happens and make the event more likely (e.g. skipping flu vaccine, consuming cheeseburgers, hand-gliding) Ex post: behaviour changes that occur AFTER an insured event happens and make recovering from that event more expensive (e.g. opting for knee-replacement surgery over painkillers, taking an expensive drug rather than more expensive remedy)

Describe the trade-off between moral hazard and risk reduction

Moral hazard: by-product of insurance contracts and creates social loss (e.g. externality of each person's risky decisions as they are borne by other people in insurance pool) Limiting provision of insurance through quota and taxes to reduce moral hazard creates different social loss by limiting the benefits of insurance for risk-averse individuals More insurance = more social loss from MORAL HAZARD Less insurance = more social loss from higher exposure to risk

How can the nature of the risk impact the severity of moral hazard?

Natural hazards (e.g. Developing Huntington's disease) cannot be controlled by individual actions so insuring against this disease does not change the individual's actions

What is the role of asymmetric information in moral hazard?

Only externalities arising from asymmetric information = 'true' moral hazard Ex ante: insurance company cannot know every risk of unhealthy choice individual makes in day to day life Ex post: insurance company does not know whether or not insured individual is truly unhealthy and requires lots of care or is just receiving lots of care because of reduced price

What determines the magnitude of moral hazard of any insurance contract?

Price distortion and price sensitivity

What three conditions must hold for moral hazard due to insurance to occur?

Price distortion: the costs of a risk or wasteful action to an individual is reduced, usually as a consequence of insurance Information asymmetry: Prevents an insured from adequately pricing a certain action Price sensitivity: individual responds to the price distortion by changing his behaviour, taking more risks or demanding more covered goods and services

How can insurers limit moral hazard?

Through price distortion

Describe some upsides to moral hazard

What if people with no insurance generally underestimate how much care they actually need or cannot afford care they value highly? This type of overconsumption = beneficial Extra preventative care: insurance coverage generally promotes preventative care; moral hazard that arises from health insurance may correct underconsumption of preventative care (e.g. breast cancer screening) The income effect: Someone with insurance (when compared to without insurance) becomes 'richer' - they can now afford expensive surgery they may have gone without