Health-specific moral hazard effects.

• Author: Koc, Cagatay

1. Introduction

   Health care consumers do not react to changes in out-of-pocket cost without considering their health. Although many outstanding studies estimate the effect of insurance on health care demand among the general populations, this effect is likely health specific, varying between consumers of different health. Consequently, predicting the effect of health insurance on the demand for health care may be more practical with reference to a specific health subpopulation. (1) In this paper, I analyze the effect of insurance on the demand for health care among consumers of similar health, which I call the "health-specific moral hazard effect."

   Health insurance may affect the demand for health care services with varying intensity, since a consumer's preferences toward health may vary by dimension of health. For example, a consumer may exhibit different actions in his decisions toward tertiary care (which may represent mortality) than toward primary care. Consequently, the relationship between the moral hazard effect and health may be dimension dependent and each health state may have different moral hazard profiles across different health care services. This paper examines the potential for such variation in the moral hazard effect in the demand for inpatient and outpatient services.

   By estimating health-specific moral hazard effects across health care services, this paper seeks to expand the existing literature on the welfare implications of health insurance. Since health insurance decreases the effective price of health care, thereby creating a wedge between the cost of care and its price, Pauly (1968) argues that additional health care used by the insured (that is, moral hazard) is welfare decreasing. Nyman (1999a, 2003), however, showing that the price subsidy that is used to pay off the health insurance contract incorporates an income transfer from the healthy to the ill, demonstrates that the conventional moral hazard effect contains both inefficient health care use, which is due to the opportunistic price effect, and efficient health care use, which is due to the income transfer that the ill obtains from the healthy and spends in part on additional health care. Thus, the welfare implications of health insurance are ambiguous. By analyzing health-specific moral hazard effects, it may be possible to conclude whether the efficient or the inefficient moral hazard effect dominates for a particular health care service. If additional health care used by insured consumers is higher for better health states compared with relatively worse health states, this suggests that the inefficient moral hazard dominates. If, on the other hand, additional health care used by the insured is higher for relatively worse health states, then the efficient moral hazard may dominate.

   The health-specific moral hazard effect may also be of some interest to those who are designing insurance policies. For example, if efficient moral hazard dominates for a particular service, then cost sharing for treatment of certain serious and life-threatening illnesses provided in this service's facilities might not be desirable. The cost sharing would require the consumer to bear risk; however, it would not provide any changes in his/her health care purchasing decision.

   Health-specific moral hazard effects may also be useful to examine the relationship between insurance status and health outcomes. For instance, if additional health care used by the insured for a particular service is higher for worse health states, it could be that less care is associated with worse health outcomes for this service. In this case, the additional health care used by the insured compared with the uninsured is worth the resources spent in producing it. In other words, for consumers in bad health states moral hazard may be reasonable. Such information can be used to make decisions regarding the allocation of resources and the design of policies for the uninsured.

   The endogeneity of health insurance complicates the estimation of the relationship between insurance and health care use. Consumers who enter a health insurance contract are not selected at random. Characteristics, such as health, may influence the decision to enter a contract and thus create a self-selection bias. If these characteristics can be hidden prior to the contract, the resulting policy may adversely affect the uninformed parties in the contract. This phenomenon is known as "adverse selection." In addition, insurance companies may attempt to control health care use of high-risk consumers, a procedure known as "screening" or "selection." Either selection bias, adverse selection, or screening potentially confounds the estimation of the moral hazard effect. However, adverse selection upwardly biases effect estimates, while screening downwardly biases these estimates, if left uncontrolled. Recognizing these potential biases, I apply an estimation technique that controls for the nonrandom distribution of insurance, incorporates the selectivity into insurance regime, and takes into account the discreteness and the nonnegativity of the use of health care. Using data from the Household Component of the 2000 Medical Expenditure Panel Survey and its Medical Conditions supplement (Agency for Health Care Research and Quality 2000), I estimate an endogenous switching model for count data, also known as a type-5 tobit model.

   I proceed as follows: Section 2 discusses the interdependence of health care and health insurance choices and briefly reviews the literature on moral hazard effects. It also contains a discussion on how the relationship between the moral hazard effect and health may differ across health care services. Section 3 delineates the econometric methodology. Section 4 provides the working definition of health and describes the health care service counts. Section 5 presents the empirical results. Section 6 provides some policy implications and concludes. Sensitivity analysis is provided in the Appendix.

2. Health Insurance, Incentives, and Moral Hazard Effects

   Consider an individual consumer who faces a one-period two-date planning horizon. At time zero, the consumer has some exogenous income. He/she knows his/her current health state and chooses his/her health insurance policy using some portion of his/her income. At the time the insurance policy is chosen, time one (that is, future) health state is unknown.

   At the beginning of time one, the consumer learns his/her new health state and applies his/her remaining income toward the purchase of consumption goods and health care. This is a model of consumer behavior relevant to interdependent decisions about health insurance and health care. (2) On the one hand, demand for health care is affected by the insurance policy of the consumer. On the other hand, the choice of health insurance plan could be affected by demand considerations, in particular by planned health expenditure and expectations about health care use. This model motivates the moral hazard effect of health insurance and provides a setting for the estimation of the interdependent demands for health insurance and health care. (3)

   A health insurance policy is a contract between an insurer and an individual. Within the duration of this contract, the individual agrees to exchange income in the form of a premium for lower prices for certain health care services in the event of poor health. After signing the contract, the insurer cannot observe the occurrence of poor health. Under this circumstance, the individual has an incentive to report worse health than actual, independent of the random event. This implies that an individual who has experienced a shock to his/her health may spend more resources on health care by overreporting the severity of the shock. In other words, because of the difficulty of specifying whether a loss has occurred, the size of the loss is affected by health insurance. This effect of insurance on the demand for health care is known as the ex post moral hazard effect, (4) which is often described as the price effect of insurance on the demand for health care: An insured individual may spend more resources on health care, since insurance decreases the effective price of health care (Arrow 1963; Pauly 1968; Zweifel and Manning 2000). (5) Indeed, the model discussed above suggests that if health care is a noninferior good, then health care demand is decreasing in the fraction of health care costs paid out-of-pocket. When a consumer purchases more generous insurance coverage, the fraction decreases, causing an increase in the use of health care.

   The ex post moral hazard effect and attempts to deal with it have been a central focus of many studies of the demand for health care. Pauly (1968) shows that the effect of moral hazard can cause insurance among some types of uncertain events to be nonoptimal even if all individuals are risk averters. Many studies document the existence of the ex post moral hazard effect by estimating the change in the consumer's health care demand in response to changes in the characteristics or parameters of the insurance contract. Newhouse et al. (1980) estimate the response to a change in deductible; Beck (1974), Cherkin, Grothaus, and Wagner (1989), Harris, Stergachis, and Ried (1990), and Hughes and McGuire (1995) to a change in dollar copayment; Scitovsky and Snyder (1972), Manning et al. (1987), and Keeler and Rolph (1988) to a change in coinsurance rate. Others document the existence of the ex post moral hazard effect by estimating the difference in health care use between the insured and uninsured (e.g., Cameron et al. 1988; Coulson et al. 1995). (6) Other studies, arguing that moral hazard creates a wedge between the cost of health care and its price, estimate the welfare loss from excessive health insurance (Pauly 1968; Feldstein 1973; Feldman and Dowd 1991; Manning and Marquis 1996). In an attempt to reduce the welfare loss...