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An Analysis of Economics of Health Care and Health Insurance

R Seenivasan

This research paper is Health insurance increases the demand for healthcare. Since the RAND Health Insurance Experiment in the 1970s this has been demonstrated in many contexts and many countries. From an economic point of view this fact raises the concern that individuals demand too much healthcare if insured, which generates a welfare loss to society. This so-called moral hazard effect arises because individuals demand healthcare that has less value to them than it costs to provide it. For that reason, modern health insurance plans include demand side cost-sharing instruments like deductibles and copayments. There is a large and growing literature analyzing the effects of these cost-sharing instruments on healthcare demand.

Three issues have recently received increasing attention.

First, cost-sharing instruments such as yearly deductibles combined with stop losses create nonlinear price schedules and dynamic incentives. This generates the question of whether patients understand the incentives and what price individuals use to determine their healthcare demand.

Second, it appears implausible that patients know the benefits of healthcare (which is crucial for the moral hazard argument). If patients systematically underestimated these benefits they would demand too little healthcare without health insurance. Providing health insurance and increasing healthcare demand in this case may increase social welfare.

Finally, what is the role of healthcare providers? They have been completely absent in the majority of the literature analyzing the demand for healthcare, but there is striking evidence that the physicians often determine large parts of healthcare spending.