Behavioral hazard in health insurance

Abstract

A fundamental implication of standard moral hazard models is overuse of low-value medical care because copays are lower than costs. In these models, the demand curve alone can be used to make welfare statements, a fact relied on by much empirical work. There is ample evidence, though, that people misuse care for a different reason: mistakes, or “behavioral hazard.” Much high-value care is underused even when patient costs are low, and some useless care is bought even when patients face the full cost. In the presence of behavioral hazard, welfare calculations using only the demand curve can be off by orders of magnitude or even be the wrong sign. We derive optimal copay formulas that incorporate both moral and behavioral hazard, providing a theoretical foundation for value-based insurance design and a way to interpret behavioral “nudges.” Once behavioral hazard is taken into account, health insurance can do more than just provide financial protection—it can also improve health care efficiency.

Figure I

Model with Only Moral Hazard

Figure II

Model with Behavioral Hazard

Figure III. Welfare Impact of a Copay Change: Behavioral Hazard versus Moral Hazard Alone

Panel A considers the welfare impact of reducing the copay to zero when there is only moral hazard to when there is also negative behavioral hazard. Panel B considers the welfare impact of increasing the copay above cost when there is only moral hazard to when there is also positive behavioral hazard.