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Insurance use none none generation tointegrate none for nonebarcode generat with Figure 7.1. Service Bene t Insurance and Moral-Hazard-Induced Use of Medical Care ISSN (insurance company) is footing part of the bill. The shaded area above the value-to-patient line is the excess cost (waste) over value received. In general, if ex ante payout is pq where is the probability that a covered event occurs, p is the price of the covered purchase, and q its quantity, moral hazard occurs if one or more of , p, or q rises because insurance is present.

We can therefore distinguish the different avenues through which moral hazard occurs. It is important to design insurance plans to deal with moral hazard. 4 Ideally, insurance would pay only for care that would be selected had the individual chosen to self-insure.

For example, consider the situation where two health states are possible, sick and healthy. Suppose the probability of becoming sick is 10 percent and that it requires medical spending of $20,000 to return to full health. The risk-averse individual prefers to pay the fair premium of $2,000 rather than self-insure.

5 If medical spending is actually. As has been noted i none none n several places, an optimal solution in this kind of moral hazard situation is for the insured to retain some part of his losses. Pauly, 1974, p. 45.

The welfare losses of moral hazard can be mitigated if some risky medical events are not fully insured. Pauly, 1968; 1974, p. 45; 1986 discusses alteratives that include the use of deductibles, co-insurance, quasi-indemnities.

See Deductibles, Co-insurance, and Other Explicit Financial Bene t Limits in Pauly, 1986, pp. 641 642. This is a standard implication of risk aversion and expected utility maximization.

See, for example, Von Neumann and Morgenstern, 1944.. Essential Insurance $30,000 when the per none for none son has insurance, the additional $10,000 spending is due to moral hazard. There are several distinct aspects to understanding the incentives that cause quantity (as opposed to price or probability) moral hazard. Reducing the price seen by the insured for medical care, even if the probability of the insured event and the quality (and hence price) of any covered good or service are unchanged, has both an income effect and a substitution effect.

The income effect transfers income from the healthy state to the sick state and allows the insured individual to purchase medical care that would be unaffordable without the income transfer. Moral hazard results from the substitution effect, the additional spending undertaken by the insured beyond the amount that would have been contracted for with the income transfers present but the non-contract price imposed. To manage moral hazard, insurers use deductibles and co-insurance.

The presence of a deductible imposes costs on the insured if a health event arises. There is therefore an incentive to prevent insured events. If an insured event occurs, however, the co-insurance amount encourages patients to make choices about care that balance the value of the additional care with its out-of-pocket cost.

Patients with chronic conditions especially have the knowledge and ability, if the incentive is present, to nd ways to reduce the costs of their long-term interventions and care. If a catastrophic event occurs, however, incentives have very little impact on the choice of treatment, and costs beyond the out-of-pocket limit are paid in full. Catastrophic coverage effectively income transfers to the sick state of nature leads to little or no moral hazard if purchased goods and services are priced at their marginal cost of provision.

See 10 for a discussion of what is needed to cause this to happen. If providers have market power, however, the presence of insurance can cause them to raise prices in response. Well-designed insurance, therefore, recognizes that in situations where the patient has no choice or control over the care received for example, the onset of appendicitis requires an appendectomy for which there is no choice, and no one would choose to have two appendectomies merely because the cost of the operation to the insured is zero co-insurance rates can be zero.

In situations where the insured has a choice about the quantity, quality, or likelihood of care this might include chronic situations, situations of routine care, and/or an identi able selection of covered services deductibles and co-insurance rates should be set to induce appropriate use of care by re ecting the true cost of care to the insured balanced by the need to transfer purchasing power to the insured in the sick state (balance the bene ts of greater risk sharing with the costs of moral.
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