If patients are completely insured against the costs of health care, will they consume more health care? Will these patients choose an equilibrium that is non-optimal to the welfare of society? These are the main concerns of moral hazard, which has influenced health care policy, thoughts, and actions in the US for decades. Such examples of moral hazard reform are present in the form of copayments, coinsurance, and deductibles, and are meant to make the patient more responsible for their care. However, these methods have contributed to the massive costs in health care spending realized by the American public. Instead of using costly measures to try and limit moral hazard, a further examination of the economic phenomenon can result in different conclusions.

Moral hazard is defined as changes in consumption of a certain good because the consumer is insured against the full cost of the good. When individuals act differently due to insurance, they are acting under ex ante moral hazard. This distinction between ex ante and ex post moral hazard, or when an individual behaves differently because they lack coverage, is important to narrow down factors that can be controlled and observed. This type of ex ante moral hazard applies to a variety of topics, but we are  interested in its implications in health care. Specifically, in health care, ex ante moral hazard refers to units of additional health care because the cost of health care reaches near zero. However, this can result in a non Pareto optimal solution because there would be an excessive drain on health care resources, as seen on the graph from Worthwhile Canadian Initiative.


Provided that marginal cost is constant, the consumer will consume at Qa, because that is where the cost of health care is zero due to full insurance. This is different from the optimal, most efficient solution at Q*, where marginal benefit intersects marginal cost. This graph shows us both consumer surplus and the producer surplus of the patient and health care provider respectively. The shaded area represents the deadweight loss suffered by society through the excessive expenditure of health care resources.

What if this deadweight loss to society was realized as a welfare gain? Professor John Nyman, from the University of Minnesota, stated that the main reason that people buy insurance is not to consume more healthcare, but rather to be able to afford health services in the event of illness. Nyman also believes that people don’t consume health care like a regular good. Rather, they only consume health care when they must due to sickness. This could necessitate a welfare gain because people are deriving more utility from each unit of health care used than the cost of the unit of health care. More importantly, because of the afore mentioned reason, they are more willing to buy other medical procedures/drugs that they wouldn’t have been able to before, because they now have insurance. The advent of this theory is highly important because of the implications it has for the uninsured.

Uninsured people, previously, would forego numerous medical procedures that would be extremely beneficial for health because of lack of insurance. For example, Malcolm Gladwell, of the New Yorker, writes about how uninsured patients would tend to have missing or bad teeth, for the simple reason that they couldn’t afford basic health care and prioritized necessities. If they were given insurance, they would better utilize the quantity of health care they could afford, for the benefit of society. Thus, the  exorbitant costs of health care spending realized by the public can actually be used to help poverty-stricken Americans.

However, public policy, at least in recent years, seems to align more with the traditional view of health insurance and moral hazard. In 2014, the Affordable Care Act health plans would increase copayments and coinsurance rates by a drastic thirty-four percent. As mentioned earlier, these policies to increase rates would hold customers more liable for their health care by making them pay more out-of-pocket costs. This, however, would serve to further increase health care costs, which have been greatly increasing over the years as seen in the FRED graph below.


Moral hazard for other institutions may have different implications than of moral hazard in health care. As we have seen in the 2008 financial crisis, the government bailout of “too big to fail” institutions may have resulted in a moral hazard problem. Because of the lack of repercussions, Systemically Important Financial Institutions, or SIFIs, could engage in riskier behavior, knowing that the government would not let them, for lack of a better word, fail. It is harder to realize Nyman’s welfare gain in this example, because more government protection could promote riskier behavior. The better solution would be the conventional moral hazard theory to hold the banks more accountable for their actions.

The conventional moral hazard theory stated that all moral hazard is inefficient because individuals will overconsume when they are insured from the full brunt of costs. The solution to this welfare waste on society is to hold individuals more accountable for their consumption. However, this has the unintended effects of drastically increasing costs, as it is in the case of health care spending. In the field of health care, this welfare loss from ex-ante moral hazard can be realized as a gain because of the nature of health care “goods”. Rather than increase cost sharing, Nyman believes that health care providers should provide broader coverage of health care to increase the welfare in society. Of course, Nyman’s theory would most likely not work in other moral hazard areas, like banking, because of the complex natures of the actors in play.


Should We Curtail Moral Hazard in Health Care?