Amy Finkelstein: Moral Hazard in Health Insurance

Moral Hazard in Health Insurance

By Amy Finkelstein
Columbia University Press, December 2014

In 1963, Ken Arrow proposed the concept of moral hazard in health insurance, the idea that health insurance may increase the demand for medical care. That creates a fundamental tension for health policy that is trying both to cover the uninsured and simultaneously reduce the level and growth of health spending.

The challenge posed in Arrow’s paper to subsequent generations of economists was whether we could verify that this theoretical notion of moral hazard and health insurance actually existed, and whether we could quantify its magnitude and explore its nature and implications.

How have we risen to this challenge? There is compelling evidence from randomized trials that health insurance affects medical spending. Those who say otherwise are ignoring the evidence at their own peril. This is a fact of life. It mat not be what we wished for, but we have to think about it, grapple with it, and think about its implications for policy.


The RAND Health Insurance Experiment, Three Decades Later

By Aviva Aron-Dine, Liran Einav, and Amy Finkelstein
Journal of Economic Perspectives, Winter 2013

Our reexamination concludes that despite the potential for substantial bias in the original estimates stemming from systematically differential participation and reporting across experimental arms, one of the central contributions of the RAND experiment is robust: the rejection of the null hypothesis that health spending does not respond to the out-of-pocket price. Naturally, however, these potential biases introduce uncertainty about the magnitude of the impact of the different insurance plans on medical spending. Moreover, the translation of these experimental estimates into economic objects of interest—such as a price elasticity of demand for medical care—requires further assumptions and machinery, which go beyond the “raw” experimental results. While economic analysis has made progress in the intervening decades in developing techniques that may offer new approaches to the economic analysis of moral hazard effects of health insurance, it will always be the case that, like the famous –0.2 price elasticity of demand estimate produced by the original RAND investigators, any attempt by researchers to apply the experimental estimates out of sample will involve more assumptions—and hence scope for uncertainty—than the direct experimental estimates themselves. This point, while straightforward and uncontroversial (we’d think), may have become somewhat lost in the intervening decades of use of the RAND estimates. Our hope is that this essay may help put both the famous experiment and its results back in context.



By Don McCanne, MD

This short book by Amy Finkelstein, “Moral Hazard in Health Insurance,” provides an excellent update that can be used to better understand the application of the concept of moral hazard to the design of health care financing. But more must be said.

The book is based on the fifth annual Kenneth J. Arrow Lecture presented at Columbia University in April 2012. Finkelstein’s lecture is covered in 30 pages. An introduction is provided by Joseph P. Newhouse (RAND HIE). Commentaries are provided by Jonathan Gruber (provider-side moral hazard), Kenneth J. Arrow himself (asymmetry of information), Joseph E. Stiglitz (markets and health care), and a brief discussion follows. Finally, Kenneth Arrow’s seminal 1963 paper, “Uncertainty and the Welfare Economics of Medical Care,” is included. This book should be in every library covering health policy.

As applied to health insurance, the concept of moral hazard is quite simple: many people will use more health care if they are protected from the out-of-pocket costs of that care. What is not so simple is how much of an impact that has and what the ramifications are. Amy Finkelstien helps us by explaining that there is much unknown, and that even the classical studies must be interpreted with great care as they are applied to today’s insurance models. Nevertheless, she makes the case that the evidence that health insurance affects medical spending is compelling.

One important concern about her presentation is that she attacks what she calls “the rhetorical case against the notion of moral hazard and health insurance” by criticizing the “alternative view” that “medical care is determined not by price but by needs.” She then seems to dismiss the great work by John Nyman plus the input by Uwe Reinhardt, not directly, but by merely including them in a quote from Malcolm Gladwell’s New Yorker article, “The Moral-Hazard Myth.” When she writes, “Those who say otherwise are ignoring the evidence at their own peril,” it seems that she is referring to Gladwell, Nyman and Reinhardt.

Unfortunately, she seems to be guilty of using a straw man analogy. I do not recall ever reading that either Nyman or Reinhardt said that price was not a factor in medical care. In fact, Reinhardt is coauthor of the Health Affairs article, “It’s the Prices, Stupid.” However, they have both made the point that need is a very important factor in accessing medical care, even when there are price barriers. Moral hazard enthusiasts need to address medical need.

The greatest problem with this book is that it advances, without requisite criticism, the widely accepted thesis that having insurance increases health care spending . This concept has resulted in the widespread application of countermeasures that erect financial barriers to care - high deductibles, greater coinsurance, tiering of benefits, and narrow networks. All of these impair patient access to beneficial care - the opposite of what a well-functioning system should be providing for us.

Is depriving patients of beneficial care harmful? Many economists seem to glibly dismiss the potential harm if it is effective in reducing spending. They cite the RAND HIE and the Oregon natural experiment as showing that harm is negligible or non-existent. Yet Finkelstein and her colleagues, in the Journal of Economic Perspectives paper on the RAND HIE, state, “attempt by researchers to apply the experimental estimates out of sample will involve more assumptions - and hence scope for uncertainty - than the direct experimental estimates themselves.” 

It is frequently stated in the lay literature that the RAND HIE and the Oregon experiment showed that the decrease in care caused by patient out-of-pocket spending does not result in adverse outcomes. That statement is incorrect. There were some adverse outcomes in both studies, but, more importantly, the studies concentrated on spending and were not powered to detect impaired health outcomes. The facts are that we do not have studies that can reliably assure us that no harm is done. Such studies would be complex, expensive and unethical.

We have a century of experience with our health care delivery system. The beneficial effects of modern health care far outweigh the detrimental effects. We do not need policy studies to try to counter this observation. It is intuitive that having better access to health care is beneficial, and, in this case, intuition is more than enough to drive policy.

From the  perspective of optimal patient care, the thesis of this book is upside-down. Rather than looking at the increase in spending that occurs when a person is covered with insurance, we should be looking at the impaired access that results from the reduction in spending due to ill-advised financial barriers erected through insurance innovations. Our efforts should be directed toward removing those barriers.

But then what about the spending that economists characterize as “increases” due to moral hazard? The answer is simple. Instead of depriving patients of beneficial care we should turn to the other methods of containing costs that have been proven to be effective in other nations.

We could start with the administrative waste that would be recovered simply by converting to a single payer system (not to mention the many other financial benefits of single payer). Just the administrative savings alone would be far more than could ever be saved through the application of moral hazard policies.

We already have high deductibles and coinsurance, and yet our health care costs are much higher than in those nations that do not use such detrimental interventions. Application of moral hazard theory has been a failure primarily because it diverted our attention away from social policies that would advance health care justice.