Moral hazard

This is a TIE-U post associated with Jonathan Kolstad’s The Economics of Health Care and Policy (Penn’s HCMG 903-001, Spring 2012). For other posts in this series, see the course intro.

This week’s papers focused on moral hazard. I and others have written a great deal about moral hazard on this blog (this link will take you to all post so tagged). So, it’s a bit hard for me to conjure up something new on the subject. Instead, I will do what bloggers do best, repeat myself.

Let’s start with the classic RAND Health Insurance Experiment (HIE) paper by Manning et al. [1]. I and others on this blog have written many posts about the RAND HIE (this link takes you to them). In one such post, I presented some of the results of the study graphically (click to see) and then wrote,

Other important findings:

  • Cost sharing reduced the use of both effective and ineffective care. The amounts of reductions for each were equal for hospitalizations and drug use. That is, it cut moral hazard (ineffective care) and also to the same extent it cut care we might think of as warranted, necessary, and valuable (effective care).
  • Cost sharing did not alter the quality of care received.
  • In general, no adverse effects on health were attributable to cost sharing with some important exceptions. The poorest and sickest 6 percent of the sample had better outcomes (including mortality) under free care for certain conditions or types of care (hypertension, vision and dental care) and serious symptoms were less prevalent for poorer people on the free plan (chest pain when exercising, bleeding, loss of consciousness, shortness of breath, excessive weight loss).
  • Risky behaviors and lifestyle choices (e.g. smoking, obesity) were unaffected by cost sharing.

It is important to keep in mind that the RAND HIE did not include participants over 64. One should be cautious about drawing conclusions from the RAND HIE results for the Medicare population. In fact, a recent paper concluded that the effect of cost sharing on the elderly are very different, in particular that higher outpatient cost sharing for an elderly population leads to increased inpatient utilization. No such “offset effect” was found in the RAND HIE.

Next, let’s turn to Pauly [2]. I recently wrote about this paper, quoting Deborah Stone’s reaction,

Moral hazard transforms health insurance from a social hero into a social villain. It transforms the social safety net from a mode of security against danger to the very danger itself. And it transforms the question of whether social insurance is desirable from an issue for democratic political debate — as it is in most countries — to an issue properly left to a technical elite. […]

Therefore (the argument goes), the supposed benefits of more insurance are illusory. Less is more.

For people without insurance, less is not more. […]

The “culture of money” in medical practice would seem to be as good a definition of moral hazard as one might want. The label and its theory might also apply to the pharmaceutical-company-doctor-medical-school nexus that leads people to “use” so many marginally effective but exorbitantly expensive drugs (see Angell 2004, 2010). Moral hazard might also apply to the medical-imaging juggernaut composed of device manufacturers, doctor-owners (again), and medical specialty societies who virtually force Medicare and other insurers to cover unproven technologies (Appleby 2008).

Stone is getting at something important, questioning whether the additional utilization we economists call “moral hazard” should really be associated with the patient. It is not at all clear that patients make or are even able to make informed choices about care. There are others in the system that deserve a little bit of the credit/blame for “moral hazard care” too.

Finally, John Nyman has offered an alternative theory of moral hazard, finding that as much as 70% of what is normally considered “moral hazard welfare loss” is actually a welfare gain.

A number of policy implications follow that differ from those implied by an assumption that all moral hazard is a welfare loss. Nyman lists them as:

  • Cost sharing is often not appropriate, particularly for cost-effective, life-saving or health-preserving interventions,
  • Subsidizing insurance premiums to encourage coverage is beneficial, and
  • High health care prices are harmful because they discourage use of care.

It is not incorrect to say that insurance promotes additional health spending. It does. If you believe Nyman’s theory, it is incorrect to say that all that additional spending is wasteful, a welfare loss. A little is. Most is not. More skin in the game is not more efficient even if it saves money. Some things are worth the price.

Moral hazard is a more challenging and challenged concept than many realize.


[1] Manning W., J. Newhouse, N. Duan, E. Keeler, A. Leibowitz and M. Marquis, (1987) “Health Insurance and the Demand for Medical Care: Evidence from a Randomized Experiment.” American Economic Review, 77:251-277.

[2] Pauly, Mark (1968) “The Economics of Moral Hazard: Comment,” American Economic Review 58: 531-537.


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