Moral Hazard under Liquidity Constraints

Moral Hazard under Liquidity Constraints, joint with Justin Sydnor and Johannes Jaspersen. NBER Working Paper 33648.

Abstract:

Spending induced by health insurance is often called moral hazard and definitionally assumed to be inefficient. We adapt standard models and show that for those living “hand-to-mouth”, the financing benefits of insurance cause a portion of moral hazard to be efficient. Although insurance’s price distortions also create some inefficient spending, the net welfare impacts of moral hazard can be positive. We present an intuitive graphical framework and formal results to distinguish moral hazard’s efficient and inefficient components. Simulations show economically significant net benefits of moral hazard in many cases. Our framework also provides a new way of modeling the “income effect'” induced by insurance, and distinguishes it from the “liquidity effect”. While both can lead to efficient moral hazard, moral-hazard benefits from the “liquidity effect” are often substantially larger. We use our framework to revisit prior estimates of Medicaid’s value from the Oregon Health Insurance Experiment. For individuals with minimal liquidity, Medicaid’s value is more than twice prior estimates.

Bullet Point Summary

• Rethinking Moral Hazard: Moral hazard in health insurance—the increased spending that comes when you get insured—is usually seen as wasteful due to insurance’s price distortion. This paper challenges that view.
• Insurance doesn’t just reduce risk. It also provides liquidity constrained people with a financing benefit. Paying healthcare costs with premiums allows individuals to smooth costs across time, even if the individual ultimately spends the same amount.
• Financing healthcare expenditures in a smooth way allows individuals to pay for care at a lower utility cost.
• Result: Not all insurance-induced spending is inefficient. We separates efficient moral hazard (beneficial spending because people can implicitly finance their costs) from inefficient moral hazard (distortions due to lower prices).
• Applying our framework to Medicaid using the Oregon Health Insurance Experiment, we find constrained hand-to-mouth recipients could value Medicaid twice as much as people with access to liquidity.