moral Hazard (reading)

Moral Hazard Overview

• Definition: Moral hazard occurs when individuals with insurance coverage engage in riskier behaviors because they do not bear the full consequences of those actions due to the coverage provided by insurance.

Case Study: Hang-Gliding Example

• Characters:

  • Tim: Opts out of hang-gliding due to lack of insurance.
  • Peter: Enthusiastic about hang-gliding, takes the risk due to his passion despite having lost insurance.
  • Jay: Has insurance, feels emboldened to participate without worry.

• Incident: Both Peter and Jay suffer accidents while hang-gliding; Tim observes from a distance.

• Consequences:

  • Jay and Peter end up with severe injuries and high medical costs.
  • Jay can afford speedy recovery due to insurance covering costs, while Peter hesitates, considering his financial limits.

Core Concepts of Moral Hazard

• Key Elements:

  1. Risk of Event X: Action can influence likelihood of negative outcomes.
  2. Insurance Coverage: Reduces personal financial risk, altering behavior.
  3. Behavioral Changes: Increased risk-taking or consumption of services due to reduced personal cost.
  4. Information Asymmetry: Insurers cannot monitor all patient behaviors, leading to higher average costs in the insurance pool.
  5. Social Loss: Increased incidences of bad events due to behavior changes result in higher costs spread over the insurance group's premiums.

• Example in Health Insurance:

  • Individuals may engage in riskier health behaviors (e.g., hang-gliding) knowing that injuries will be covered, leading to more accidents than if they bore the full costs.

Types of Moral Hazard

• Ex Ante Moral Hazard:

  • Changes in behavior before an event, increasing its likelihood (e.g., engaging in extreme sports).

• Ex Post Moral Hazard:

  • Changes in demand for treatments after the fact, which can lead to excessive consumption of medical resources (e.g., opting for expensive treatments covered by insurance).

Economic Implications

• Insurance Pool Dynamics:

  • All members pay for each other's risky behavior through collective premium costs.

• Graphical Representation:

  • Effective Price Changes: With insurance, the price of risky behavior (like healthcare) drops, increasing consumption (shifting the demand from QU to QI).
  • Social Loss: Difference in beneficial outcomes leads to increased costs and inefficiencies for the pool.

Mitigating Moral Hazard

• Insurance Design: Strategies to mitigate moral hazard include:
  • Copayment: Fixed amount per treatment (e.g., $25 per doctor's visit).
  • Coinsurance: Percentage of coverage paid by the insured.
  • Deductibles: Initial amount paid out of pocket before insurance kicks in.
  • Monitoring & Gatekeeping: Involves primary care providers to assess need for specialists or treatments.

Empirical Evidence and Studies

• RAND Health Insurance Experiment: Showed increased likelihood of visits for injuries under full insurance compared to plans with cost-sharing.
• Oregon Medicaid Study: Confirmed that those with insurance utilized medical services more frequently, though overall health outcomes showed no significant improvement.

Trade-offs in Health Insurance Policies

• Risk vs. Moral Hazard: Balance needed between providing comprehensive insurance and costs associated with increased reckless behavior.
• Public Policies: National insurance can provide coverage but may lead to significant moral hazard and higher taxes due to the nature of collective risk pooling.

Conclusion

• Importance: Understanding moral hazard is essential for developing effective health insurance policies that balance risk protection and behavioral incentives. Strategies vary in effectiveness and need constant evaluation to optimize insurance contracts for both providers and consumers.