Moral Hazard

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Adverse Selection in Germany

July 27, 2011 in Health Insurance, International Health Care Systems | No comments

In Germany, poor and middle class individuals must use public insurance, but well-off Germans can choose between using public and private insurance.

“In Germany, about 90% of the population is publicly insured (Colombo & Tapay, 2004). Buying public insurance is mandatory for dependent employees with a regular employment contract as long as their income does not exceed the so-called compulsory insurance threshold. The public insurance premium equals a certain percentage (nowadays about 15% that are equally shared between the employer and the employee) of gross income up to the so-called contribution ceiling, and equal to it thereafter.”

Why would someone want private insurance? Coverage is universal in the public system and the deductibles and co-payments are limited. Here’s why”

“Contributions for private health insurance are mainly based on health and age, so buying private insurance is especially attractive for young individuals. As a consequence of this, and because of the fact that private insurers are allowed to reject individuals, the risk pool of the private insurers is much better than in the public system…Privately insured individuals can buy better care, e.g. treatment by the head doctor in a hospital or a single room in a hospital, but this comes at a higher price.  Deductibles and co-payments are much more common, and many insurers offer a rebate if an individual did not use medical services in the past calendar year.”

In fact, a paper by Hullegie and Klein (2011) finds that individuals with private insurance are much less likely visit a doctor. This is likely due to adverse selection although moral hazard may also play a role since private insurance plans have higher copayments and deductibles.

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Mass Circumcision and Moral Hazard

January 18, 2011 in Uncategorized | 4 comments

In Swaziland, a nationwide campaign is under way to circumcise 160,000 males by the end of this year.  Not 160,000 male babies, 160,000 adult males.  In a country with less than 1.5 million people, this is a huge undertaking.

Why would the government of Swaziland promote adult circumcision so strongly?  Here’s the answer:

“…a randomized controlled trial in South Africa (later confirmed by studies in Uganda and Kenya) found that circumcised men are as much as 60 percent less likely to contract HIV through heterosexual sex. Scientists do not yet know exactly why, but the study was so convincing that it was stopped after 18 months, because preventing the uncircumcised control group from getting the procedure would have been unethical.”

“Currently, 20 percent of Swaziland’s population are HIV positive…Nearly half of women ages 25 to 29 and men 35 to 39 are infected.”  Thus, circumcision is seen as a way to reduce the spread of HIV.

However, could circumcision actually increase the prevalence of HIV in the country? This may be the case if moral hazard strikes.

Moral hazard would occur if young Swazi males now overestimate their protection against HIV and these men become more promiscuous.  In fact, after circumcision “Some of the men have the misconception that they’ll be 100 percent safe.”  Fortunately, NGOs are providing counseling before and after the procedure to educate the Swazi men on the post-circumcision risk and the need to use condoms.  For the sake of their future, let’s home the young men listen.

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Moral Hazard in Action

August 12, 2010 in Economics - General | No comments

About two weeks ago, I was driving to work and a rock from below a car in front of me flew of the ground and made a quarter-sized spiderweb on my windshield.  ₣@¢כ!!! Fortunately, my insurance company fixes a windshield for free if the damage is smaller than the size of a dollar bill.  I called the insurance company, they ordered a vendor to come to my office and fixed the windshield while I was at work. Perfect!

While the work was getting done, the first question I asked myself was: ‘Why does the insurance company do this?’  This could be a case of preventive care saving money.  If the small ding was not treated quickly, the whole windshield might break and the insurance company would be liable for these damages.  By paying a small amount of money up front, it can save money in the long run.  This is the argument many public health officials make for making insurance pay for more preventive care.  On the other hand, it could just be a low cost service that their customers appreciate.  In this case, no cost might be saved (if it was highly unlikely that a small ding would lead to a full windshield shatter) but providing this service may maintain consumer loyalty.  This is analogous to the modifications to the breast cancer screening that no insurance company will adopt.  Although reducing the breast cancer screening frequency for low risk women would reduce cost, failing to reimburse these services would likely lead to a large number of consumers leaving that insurance plan.

The second concept I want to talk about is moral hazard.  I learned from the windshield fixer that some companies are approaching individuals at carwashes and ask them if they want small dings fixed.  The consumer would not have fixed the ding if they had to pay for it (since they have not already).  When the service is free, however, then they often decide to have the ding fixed.  The windshield fixers benefit since they receive compensation from insurance companies. I even learned about cases of fraud where suppliers will claim to fix a friend or relative’s windshield ding, when none existed.  The supplier and their friend can split the insurance company payment.

After this post, maybe I’ll change my motto.  The Healthcare Economist: blogging on health care…and windshield dings.

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Do higher copayments decrease health care costs?

January 20, 2010 in Health Insurance | No comments

Merrill Goozner of GoozNews writes the following:

The share of health care costs borne by individuals has remained fairly steady over the past several decades, and that is the prime argument behind conservative and economist claims that making patients have “more skin in the game” will drive health care costs lower. That ignores the fact that most people (except those in some union plans) have experienced fast rising co-pays and deductibles for years. As health care inflation skyrocketed, employer-paid premiums skyrocketed. But so did individual payments in equal proportion. Where’s the evidence that the skyrocketing co-payments of the past decade held down health care costs?

Do higher copayments hold down health care costs?  In general, the answer is YES.  As Mr. Goozner has mentioned, there has been much evidence by economists that when patients pay more money out of their own pocket, they consume less medical care.  The RAND health insurance experiment finds this to be true in the strongest terms.

However, there are exceptions. For instance, higher co-payments on pharmaceuticals will decrease drug use, but lower pharmaceutical adherence may increase hospitalization rates thus increasing healthcare spending. This is a problem of how to design the insurance contract, not a violation of the central tenet of moral hazard (i.e., when someone else pays for a good, you will consume more of it).  In fact, I have written extensively on the issue of moral hazard.

Additionally, on a macro level, the majority of health care costs come from serious, end-of-life care. In these situations, the physician has much more control over the services provided than the patient.  Further, once a person has reached this stage, the copayments are likely small as the deductible has already been met.

The major problem with Mr. Goozner’s argument is that he does not distinguish between correlation and causation.  In recent history, copayments have increased and so have costs, but this does not mean that higher copayments caused the increased costs or even that they did little to stem the tide of cost increases.  Health care has changed on many dimensions including medical technology, how doctors treat patients, hospital and provider consolidation, etc.  The counterfactual against which one should measure the impact of higher copayments is the following scenario: what if all the exact same changes took place in recent history but copayments did not change over time.  How different would costs be from our current state?  Likely, healthcare care costs would have risen even faster than without the increased copayments.  Nevertheless, since one can never redo the past, this exercise is simply a thought experiment.

Logically, however, it makes sense that higher copayments and deductibles decrease medical costs.  If you go to the dentist and they want you to pay a few hundred dollars for an x-ray, you will be much more likely to acquiesce if your insurance is paying for the x-ray rather than it is coming out of your own pocket.

Higher copayments do decrease medical utilization, but they are just one of many factors that influence aggregate healthcare costs.

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Pharmaceuticals as an excuse, not treatment

January 11, 2009 in Pharmaceuticals | 3 comments

Should doctors prescribe pharmaceuticals to patients who have heart disease.  Statins and ACE inhibitors are frequently prescribed to patients with cardiovascular problems.  These medications have been shown to decrease the risk of heart attack in clinical trials, but could they actually increase the risk of a heart attack in the real world?

The answer is yes if taking the drugs changes behavior.  Without any pharmaceutical treatment, patients with a family history of a heart attack may decide to exercise more and eat healthier. Once the patient starts taking the pharmaceuticals, however, this may give them less of incentive to take care of themselves.  The drug can give them an excuse to engage in an unhealthy lifestyle.

 ”Yeah, I’m still smoking and eating philly cheesesteaks for breakfast, but I’m taking a statin so I’ll be fine.”  It is true that clinically statins reduce the risk of heart attack.  If heart medications also produce a sense of false security and adversely affect patient lifestyle behaviors, then prescribing these medications may actually be counterproductive.

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Subprime Lending

December 12, 2007 in Economics - General | Permalink

One of the biggest news stories this year is the collapse of the subprime mortgage lending market. Why did this happen? How much do we really know about subprime lending?

A working paper by William Adams, Liran Einav and Jonathan Levin examines the subprime market for automobile loans. The authors find that liquidity constraints are a major force in shaping the subprime loan market. They find that car loans spike in January through March. Why is this? Poor individuals often take out a loan against their tax rebates. These rebates can be very high–up to $4500–and these individuals will use these rebates to help finance a car purchase.

Finance charges for these loans are very high. Interest rates usually surpass 20% and often at the state-mandated 30% interest cap. A $11,000 loan paid off over 42 months would incur $6000 of finance charges.

Yet it seems that loan demand within the subprime market is not very responsive to interest rates. It is, however, much more responsive to the amount of the down payment.

We estimate that a 100 dollar increase in the minimum down payment reduces the probability that an applicant will purchase by 0.0301, while a 100 dollar increase in the car price reduces the purchase probability by only 0.0034. That is, a 100 dollar increase in the minimum down payment has the same e¤ect as a 900 dollar increase in car price. This can still be explained in the absence of liquidity constraints, but it requires a much higher annual discount rate of 427 percent.

The authors found evidence of both moral hazard and adverse selection in the subprime market. Moral Hazard means that individuals are more likely to default on large loans. Adverse selection occurs when high risk borrowers desire large loans. The authors find that when a loan amount increases $1000, the default rate increases 24%. Sixteen percentage points is due to moral hazard and the rest is due to adverse selection.

Are there any ways to mitigate these market failure problems? The authors find that “risk-based minimum payments play a substantial role in mitigating adverse selection in financing choices.” These factors lead to the observation that “in practice, observably risky buyers end up with smaller rather than larger loans because they face higher down payment requirements.” Modern credit scores give the lender more information regarding the credit-worthiness of the borrower and help to match high-risk borrowers with smaller loans.

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