Health Insurance and Moral Hazard: A Misdiagnosis

Abstract

A common misunderstanding of moral hazard emerges from an inaccurate definition of health-care insurance. What we call health insurance is actually a bundle of two services — insurance for catastrophic care and subsidies for routine care. The insurance portion covers insurable medical events and the subsidized portion provides additional compensation to employees and taxpayer-funded coverage for the poor and elderly. This bundling approach has made it difficult to draw a bright line between what is medical insurance and what is merely a tax-free subsidy of the cost of routine care. As a result, many economists have chosen to include the over-consumption of routine care in the moral hazard bundle instead of attributing the behavior to the subsidy. This approach leads to confusing discussions of public policy.

Keywords: moral hazard, subsidies, health care, insurance

JEL Classification: I12, I13, I18