Getting Better, Feeling Worse: Cure Rates, Health Insurance, and Welfare

Abstract

We model a health insurance market where rising cure rates for a disease may paradoxically diminish welfare and even negate the desirability of health insurance altogether. In the model, rising cure rates can affect welfare in two ways: (1) directly, by improving some individuals' health, and (2) indirectly, by influencing the mode and parameters of the optimal insurance contract and, thus, ex post financial wealth distribution. (“Mode” refers to the qualitative specifications of the contract — presence or absence of indemnities and full, partial or zero coverage of treatments received. “Parameters” refers to the quantitative features of the contracts — level of nonzero indemnities, deductibles and premiums.)

Graboyes (2000a) compares the relative efficiency of deductibles and indemnities in deterring low-benefit patients (those whom treatment is less likely to cure) from seeking expensive medical care. The current paper asks how optimal insurance and associated welfare change as curative technology improves. Deterring some but not all patients requires deductibles or indemnities because one’s H/L status is known to all, but not legally verifiable.

We find that advances in curative power may reduce welfare and even eradicate health insurance. This is because at higher cure rates, higher indemnities and deductibles are needed to deter patients from seeking treatment. Given certain population parameters, higher cure rates can only reduce welfare. The findings raise some practical, empirical, and ethical questions; some of these issues are enumerated in the conclusion.

Keywords: health insurance, technological change, heterogeneity, indemnities

JEL Classification: I11, G22, D81