Question

Economist disagree about the likely extent of moral hazard in the health care system. What are 2 arguments/evidence to suggest that moral hazard does exist? What are 2 arguments/evidence to suggest that moral hazard does not exist?

Answer 1

Moral hazard is a bit of a misnomer. There are no normative, morality-based elements to the economic sense of moral hazard. Instead, moral hazard means that a situation exists where one party has an incentive to use more resources than otherwise would have been used because another party bears the costs. The aggregate effect of moral hazard in any market is to restrict supply, raise prices and encourage overconsumption.

Moral hazard is often misunderstood or misrepresented in the health insurance industry. Many argue that health insurance itself is a moral hazard since it reduces the risks of pursuing an unhealthy lifestyle or other risky behavior.

This is only true if the costs to the customer, or the insurance premiums and deductibles, are the same for everyone. In a competitive market, however, insurance companies charge higher rates to riskier customers.

Moral hazard is largely removed when prices are allowed to reflect real information. The decisions to smoke cigarettes or go skydiving look different when it means premiums can increase from $50 per month to $500 per month.

Insurance underwriting is crucial for this very reason. Unfortunately, many regulations designed to promote fairness end up clouding this process. To compensate, insurance companies raise all rates.

In the United States, moral hazard in health insurance was already encouraged before Obamacare. Tax incentives encourage employer-based health coverage, placing consumers farther away from medical costs.

Additionally, all uninsured Americans are required to purchase a policy or pay a fine, although there are many "hardship exemptions" to the fine. Knowing the risks and costs to insurance companies would skyrocket, this mandate is intended to keep them in business by forcing low-risk consumers to buy.

Restricting costs, mandating employer coverage and requiring minimum benefits further drive a wedge between the consumer and the real cost of health care. Premiums have predictably spiked since passage of the Act, consistent with economic theory about moral hazard.

If insurers actually transferred income to an ill person in one lump-sum payment, the welfare implications of moral hazard would be unambiguous. For example, consider Elizabeth, who has just been diagnosed with breast cancer. Without insurance, she would purchase only the $20,000 mastectomy required to rid her body of the cancer. If she had purchased an insurance policy for $4,000 that paid off with a $40,000 cashier’s check upon diagnosis of breast cancer, she might purchase the $20,000 mastectomy and also a $20,000 breast reconstruction procedure. For economists, this behavior implies that the additional $40,000 in income from the insurance pool had increased her willingness to pay for the breast reconstruction so much that it is now greater than the $20,000 market price, causing her to purchase the second procedure. This moral hazard is efficient because she could have spent the additional $40,000 on anything she chose but opted to purchase the breast reconstruction. The purchase of this additional procedure represents a moral-hazard welfare gain to the extent that with the additional $40,000 in income, she would have now been willing to pay more than the $20,000 that it cost to produce the procedure.