Moral Hazard versus Adverse Selection in Health Care Reform: We mentioned moral hazard only briefly—and primarily in the context of how this might aggravate the adverse selection problem. In this exercise, we explore moral hazard a bit more in the context of health insurance. (Both part A and part B of this exercise can be done without having done section B in the chapter.)
A. Suppose throughout that individuals do not engage in riskier life-styles as a result of obtaining health insurance.
(a) How does this assumption eliminate one form of moral hazard that we might worry about?
(b) Suppose that a unit of health care x is such that it can be provided at constant marginal cost that is the same for all patients. Illustrate a patient’s demand curve for x as well as the MC curve for providing x.
(c) Suppose demand for health care services is equal to marginal willingness to pay. If the patient pays out-of-pocket for health care, how much would she consume assuming that health care services are competitively priced (with health care providers facing negligible recurring fixed costs)?
(d) Suppose next that the patient has insurance coverage that pays for all health related expenses. How much x does she consume now?
(e) Moral hazard refers to the change in behavior that arises once a person enters a contract.
Have you just uncovered a source of moral hazard in the health insurance market? Explain how this results in inefficiency.
(f) Now replicate your picture two times: Once for a patient where the moral hazard problem is small, and once for a patient where it is large. If insurance companies cannot tell the difference between these two individuals, how does this asymmetric information potentially give rise to adverse selection?
B. Consider two alternative proposals for health care reform: Under proposal A, the government mandates that everyone buy health insurance, restricts insurance companies to provide a single type of policy with generous benefits — and then lets the companies compete for customers to sell that policy. Under proposal B, the government sets up “health care savings accounts” for everyone and allows insurance companies to offer only policies with high “deductibles”. Under this latter policy, consumers would then pay for most health related expenditures using funds in their health care savings accounts and could convert any balance to retirement accounts when they reach the age of 65 (and thus become eligible for government health care for the elderly — called Medicare in the U.S.) Insurance under policy B is therefore aimed only at “catastrophic” events that cost more than the deductible of the policy.
(a) Suppose you were concerned about excessive health care costs. How would the two different proposals aim at addressing this?
(b) If you thought the primary problem arose from the moral hazard analyzed in part A of this exercise, which policy would you favor?
(c) Suppose instead that you thought the primary problem arose from the rising cost of health insurance linked to increasingly severe adverse selection (unrelated to the moral hazard problem analyzed in part A) and a growing pool of uninsured people. Which policy might you more likely favor?