The Economy by Peter R. Crabb: Health exchange could boost incentives to take risks

PETER R. CRABB, professor of finance and economics at Northwest Nazarene University in NampaAugust 13, 2013 

Peter R. Crabb

The Broncos are getting ready for a great football season, predicted to finish first in the Mountain West Conference. Another team hoping to finish first this fall is the Idaho Health Insurance Exchange Board. Opening day is Oct. 1, but will the team be ready?

Even if the insurance exchange website is up and running in time, the real excitement in this game will be how insurance consumers act. Many will rate the success of the exchange and its website by the number of consumers who sign up. But success in this market should be measured by how much consumers’ health improves and how much overall spending on health care declines. Economic theory tells us that more health insurance consumers means more spending and more risk of poor health.

A key principle of economics is that people respond to incentives. If more people buy insurance, there is actually a risk that consumers will be less healthy and spend too much on health services.

The health care insurance market is subject to an incentive problem called moral hazard. This adverse market condition occurs when the buyers of a particular product take greater risks because they have less incentive to be careful about their losses.

Moral hazard would not be much of a problem in insurance markets if the sellers could accurately measure and mitigate the risks their customers take. For example, after buying car insurance, people tend to drive more aggressively than they would if they were fully responsible for the costs of an accident. But you don’t see your insurance agent following you around to see if you are driving safely. The insurance company just can’t keep close tabs on you.

Since they can’t be everywhere all the time, insurance companies take a number of actions, such as requiring high deductibles, to avoid moral hazard. But they can never monitor all their clients’ behavior, and they incur costs to check client health and insure good practices by doctors.

To cover these substantial costs they usually charge higher rates. But the insurance industry now has a mandate to cover all applicants no matter their health risks.

Unless a large number of low-risk people, like the young, sign up through the insurance exchange, companies will have to raise their rates.

Young people often choose not to have health insurance because they know themselves to be low risk. But regardless, any individuals without insurance have a strong incentive to take care of themselves. The moral hazard problem will only increase when this group is forced to purchase insurance and their incentive to take care of themselves declines.

Consider what has happened in the banking industry as deposit insurance grew. Banks take on more risk than they would otherwise when they are reassured the government will cover depositors if things go sour. Health care is now just another guarantee from the government, so the incentives to take risk grow.

When the Broncos score more points than the other team, they know they have won. More consumers for the health insurance exchange is not a sign of success.


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