Why moral hazard fails in health care

I’m going to take the time to review a topic that is one my pet peeves, one you hear bandied about all the time in discussions of more consumer directed health care. It’s a topic I came back to repeatedly on my old blog – the moral hazard.

Basically, the moral hazard is the idea that people insulated from risk behave differently than people exposed to risk. For instance, once you have good car insurance, you may drive less carefully, because you are more protected. In health care, some apply to moral hazard to posit that once you have good insurance, you are more likely to use health care – even if you don’t need it. In my favorite example of this (because I find it amusing, not because I agree), if we all had employer paid grocery insurance, we would demand filet mignon instead of hamburger. This would evidently lead to skyrocketing food costs, the end of sales, and mass starvation.

It’s important to understand that people who apply the moral hazard to health care believe that people are using too much, and that’s why our costs are too high. They believe that if we somehow changed health care, and exposed people to the true costs, they would become better consumers, and the whole system would cost less. Knowing that more than 45 million people have no health insurance, and tens of millions more are underinsured, I tend to think the biggest problem – and the one that most people feel – is because they’re not getting enough good care.

But let’s take the moral hazard argument seriously. I believe it fails, both in a theoretical sense, and in an empirical one.

As a theory, the moral hazard in health care was first described only about 40 years ago in a seminal paper by Mark Pauly. And it’s still just a theory. Like many theories, it has its good points and bad; it’s not an undisputed law. For instance, recent work by John Nyman explains that the moral hazard may actually do good in health care by encouraging people who otherwise would not seek care to do so. We want sick people to get care.

And think about it. That supermarket example isn’t even remotely comparable. If I made colonoscopies free tomorrow, no one would start picking them up by the dozen. If I declared no one would ever have to pay for chemotherapy again, you wouldn’t ask for extra. If surgeons refused to accept payment for appendectomies anymore, would anyone go and get one just for the hell of it? We have a hard enough time getting people to do the things we want them to do to be healthy without having to expose them to more hardship to get them.

I love filet mignon. No one loves going to the doctor.

Moreover, this argument assumes that we have no skin in the game. Really? The average employer provided family health care policy in the United States is over $13,000. And they still have co-pays and co-insurance. I have phenomenal health insurance through my job and it still costs me $100 to take my kid to the ER. I feel that. My prescriptions have co-pays, sometimes up to $25 dollars. That’s money. Many, many people have it much worse. People with insurance, too many of them, go bankrupt every year from medical expenses. They aren’t shielded from the costs.

But you know I like evidence, and it’s available here as well. The most comprehensive health policy study ever performed was the RAND health insurance experiment:

The HIE was a large-scale, randomized experiment conducted between 1971 and 1982. For the study, RAND recruited 2,750 families encompassing more than 7,700 individuals, all of whom were under the age of 65. They were chosen from six sites across the United States to provide a regional and urban/rural balance. Participants were randomly assigned to one of five types of health insurance plans created specifically for the experiment. There were four basic types of fee-for-service plans: One type offered free care; the other three types involved varying levels of cost sharing — 25 percent, 50 percent, or 95 percent coinsurance (the percentage of medical charges that the consumer must pay). The fifth type of health insurance plan was a nonprofit, HMO-style group cooperative. Those assigned to the HMO received their care free of charge. For poorer families in plans that involved cost sharing, the amount of cost sharing was income-adjusted to one of three levels: 5, 10, or 15 percent of income. Out-of-pocket spending was capped at these percentages of income or at $1,000 annually (roughly $3,000 annually if adjusted from 1977 to 2005 levels), whichever was lower. The 95 percent coinsurance plan in the study closely resembled the high-deductible catastrophic plans being discussed today.

I could write volumes on the meaning of the results, and the good and bad things about this study. It has been interpreted and misinterpreted too many times to count. But here’s the gist of that they found: People in the high deductible plans – those most exposed to health care costs – did spend significantly less and consumed less health care. And, yes, much of that care was unnecessary, as healthy people did not suffer negative consequences from forgoing care. BUT, and this is important, poorer participants with hypertension avoided necessary care, and saw their mortality rates rise significantly.

Removing the moral hazard did no harm in the majority of patients (which is touted often as the result of the study) because they were healthy. And, of course, getting less care when you’re healthy leads to few short term negative results. But for those who were unhealthy, who comprised a minority of patients in the study, removing the moral hazard led to significant and dangerous consequences.

And that’s the most important lesson from all of this. Removing the moral hazard as it relates to health insurance is fine for most people. Yes, if we make it more expensive to seek care, if we demand more “skin in the game”, if we remove the moral hazard, people will seek less care. That’s fine for healthy people; it’s terrible for those who are ill. But for whom is the health care system intended?