Session: Health Insurance Markets
Room: Upson 215
Time: Tue 10:15-11:45

Presenter: Cagatay Koc (University of Texas at Arlington. Economics)

Discussant: John Nyman (University of Minnesota)

Abstract

Does a decrease in the price of medical services increase consumer welfare in the presence of moral hazard? This is the central question of this paper. For many years following the early work on moral hazard in health care, the conventional wisdom posited a negative answer; due to moral hazard, a price decline would exacerbate excess consumption and lower consumer welfare. In recent years, the conventional wisdom has been revised, culminating in the important work of Gaynor, Haas-Wilson and Vogt (2000)* , which demonstrates that a competitive insurance market “leaves consumers at least as well off under lower prices as under higher prices.” In their model, the focus is on the insurer, who modifies the insurance policy co-insurance rate while the consumer passively keeps the insurance policy. We choose to view the consumer as being pro-active, optimally changing his/her intended insurance plan and choice of consumer goods and medical services in the light of health status uncertainty, given a competitive health insurance market. This approach allows us to evaluate the claim of those who support health care “reform” based on the establishment of a health insurance “exchange,” within which insurers will compete for customers who are free to select from a wide variety of competitively priced insurance plans and are able to switch plans as easily as they switch auto or homeowners insurance policies. Supporters of an exchange argue that it will lead to lower insurance premiums and, ultimately, a reduction in the price of medical care. We focus on the consumer “contract choice effect” – the ability of the consumer to choose a different insurance plan in response to a change in the gross price of medical services – as the mechanism critical to evaluating the consumer welfare effect of such a price reduction.

We show that the contract choice effect has significant implications for consumer welfare. For the case of a decline in the gross price of medical care, for example, the insured consumer might choose a lower cost health plan and be willing to bear a higher percentage of the gross price of actual utilization. And, because the consumer then confronts a higher share of the cost of ongoing health care, he/she might reduce excess consumption. Our results show that the increase in excess consumption will be lower than conventional wisdom suggests and, under certain explicit conditions, excess consumption will fall instead of rise. This is moral hazard in reverse. As a consequence, consumer welfare (the sum of moral hazard welfare loss and the value of risk avoidance) will decrease less than conventional wisdom suggests and may actually rise instead of fall.

Key Terms

moral hazard; insurance contract choice effect; consumer welfare

Authors:

Richard Dusansky (University of Texas at Austin. Economics) and Cagatay Koc (University of Texas at Arlington. Economics)