Cecilia Diaz Campo (Western University)(Webinar)

“Dynamic Moral Hazard in Nonlinear Health Insurance Contracts”

Abstract. Standard health insurance contracts generate nonlinear pricing through the presence of deductibles and caps on out-of-pocket spending, in which the out-of-pocket price paid by consumers decreases as the cumulative use of health care increases. This nonlinear benefit structure, coupled with the uncertainty intrinsic to future health care demand, provides dynamic incentives for consumers’ choices: health care utilization today reduces future expected prices. Standard analyses of insurance contracts study the trade-off between the welfare gains from risk protection and the welfare losses from moral hazard, which I relabel as static moral hazard. In this paper, I study a new source of moral hazard, dynamic moral hazard, which I define as the additional health care utilization when individuals internalize that current utilization lowers future expected prices via the nonlinearities of the contract. By leveraging the random assignment of families to health plans from the RAND Health Insurance Experiment, I am able to focus specifically on moral hazard, avoiding the typically confounding adverse selection present in insurance markets. I develop and estimate a dynamic, stochastic model of weekly health care utilization at the family level that incorporates the dynamic pricing effects. My estimation framework allows for flexibly-correlated multidimensional unobserved heterogeneity related to family health risk, preferences for visiting a doctor, and price sensitivity. I document that 40 percent of total moral hazard is attributed to dynamic moral hazard. Using my model and estimates, I study the welfare implications of dynamic moral hazard in the setting of employer-sponsored health insurance. My results show that the presence of dynamic moral hazard can severely dampen the welfare gains associated with higher cost-sharing and plays a crucial role, distinct from static moral hazard, in determining optimal insurance contract design.