The Truth about Moral Hazard and Adverse Selection. Eighteenth Annual Herbert Lourie Memorial Lecture on Health Policy.

This brief is actually going to have two levels. One level will go with the advertised title, and I’ll tell you my current views on the truth about moral hazard and adverse selection. Adverse selection will serve as somewhat of a handmaid of moral hazard, as you will see. That’s one level. The other level, though, which continues to surprise me, is that these two topics—they’re two buzzwords from insurance theory—have generated an enormous amount of policy interest and, yes, passion. Some people passionately believe some things about moral hazard that others passionately disbelieve. And so as part of this second level I will draw back a bit from the actual subject matter to ask a kind of positive public policy question: Why is it that some people can get so passionate about a subject that seems fairly esoteric?health insurance, adverse selection, moral hazard

Time, Risk, Precommitment, and Adverse Selection in Competitive Insurance Markets

This informal paper explores models of competitive insurance market equilibrium when individuals of initially similar apparent risk experience divergence in risk levels over time. The information structure is modeled in three alternative ways: all insurers and insureds know risk at any point in time, current insurer and insured know risk, and only the individual knows risk. Insurers always know the average risk. It is shown that some models lead to “backloading” of premiums in which initial premiums are less than initial period expected expense, and that other models lead to “frontloading” of premiums and policy provisions of “guaranteed renewability.” Finally, it is shown that guaranteed renewability greatly reduces the possibility of adverse selection.

The Effect of State Community Rating Regulations on Premiums and Coverage in the Individual Health Insurance Market

Some states have implemented community rating regulations to limit the extent to which premiums in the individual health insurance market can vary with a person�s health status. Community rating and guaranteed issues laws were passed with hopes of increasing access to affordable insurance for people with high-risk health conditions, but there are concerns that these laws led to adverse selection. In some sense, the extent to which these regulations ultimately affected the individual market depends in large part on the degree of risk segmentation in unregulated states. In this paper, we examine the relationship between expected medical expenses, individual insurance premiums, and the likelihood of obtaining individual insurance using data from both the National Health Interview Survey and the Community Tracking Study Household Survey. We test for differences in these relationships between states with both community rating and guaranteed issue and states with no such regulations. While we find that people living in unregulated states with higher expected expense due to chronic health conditions pay modestly higher premiums and are somewhat less likely to obtain coverage, the variation between premiums and risk in unregulated individual insurance markets is far from proportional; there is considerable pooling. In regulated states, we find that there is no effect of having higher expected expense due to chronic health conditions on neither premiums nor coverage. Overall, our results suggest that the effect of regulation is to produce a slight increase in the proportion uninsured, as increases in low risk uninsureds more than offset decreases in high risk uninsureds. Community rating and guaranteed issue regulations produce only small changes in risk pooling because the extent of pooling in the absence of regulation is substantial.

Health Employment, Medical Spending, and Long Term Health Reform

This paper explores the relationships between the growth in the medical workforce in an aging society and employment in other sectors of the economy, based on data from the United States since 1985. Employment in medical services grew, but did not displace employment in other sectors uniformly. Instead, regression analysis shows that medical workforce growth produced contemporaneous reductions in relative employment in the manufacturing, construction, and information sectors, while being associated with growth in other services and public administration. Import penetration and productivity growth mattered, but much of the displacement remains even after controlling for these factors.

Value Based Cost Sharing Meets the Theory of Moral Hazard: Medical Effectiveness in Insurance Benefits Design

The conventional theory of optimal coinsurance rates in health insurance in the presence of moral hazard indicates that, in situations of equal risk characteristics, coinsurance should vary if the price-responsiveness or price-elasticity of demand for different medical services varies, and should be larger for the more price responsive services. An alternative theory called "value-based cost sharing" indicates that coinsurance should be lower for services with higher (marginal) benefits relative to costs. This paper reconciles the two views. It shows that, if patient demands are based on correct information on benefits and costs, the conclusion of the conventional view is identical to the conclusion from the value-based approach. If patient demands differ from correct demands, it is shown that optimal coinsurance depends both on the extent and direction of information imperfection and on price-responsiveness or price elasticity. The paper also shows, as an alternative to adjusting coinsurance to deal with information imperfection, that providing better information which affects patient demands can be superior if uninformed patient demands exceed informed patient demands, but value based cost sharing can be superior to providing information (even if the cost of information is minimal) when patient demands fall short of informed demands. An extended numerical example illustrates these points.