Let's imagine a scenario: let's say that you're standing at the top of a ski run, all decked out in your gear and ready to turn down the hill and go. Let's also suppose that this run you're about to take on is above your current skill level. In such a situation, you might be a little apprehensive, a little worried, and somewhere in your mind you are probably considering the likelihood of losing control, falling/crashing, or even getting hurt. As you turn your skis down the hill, you are likely considering how aggressive or cautious to be as you descend.

As a final consideration, ask yourself this question: would you proceed any differently if you had NO health insurance? Would that change how aggressively you might ski that hill? If you answered "yes" (or even “a little”), then you just experienced moral hazard.

The topic of moral hazard is one you will find sprinkled all over health-related blogs and journal articles, and the concept itself has been used as justification for the existence of insurance co-pays and deductibles. However, thoughts about moral hazard and its impact on care utilization have evolved over the years, and it behooves anyone interested in the ever-changing landscape of health policy to not only understand the concept, but also the current theories on its implications.

What is moral hazard?

Moral hazard refers to how an individual's behavior changes when they have insurance. In the ski example that opened this article, those who would behave differently depending on their insurance status are basically saying that with insurance they would endure more risk. If you engage in more risky behavior you are more likely to get hurt and therefore are more likely to need medical care and incur healthcare expenditures. Skiers who may ski slightly more aggressively when insured (or, analogously, more cautiously when uninsured) engage in moral hazard. In truth, this example illustrates a specific type of moral hazard called ex-ante moral hazard, which refers to changes in behavior prior to the need for healthcare services. The other type, ex-post moral hazard, occurs after you experience a health-related event that requires you to receive care, and refers to changes (specifically, the increase) in utilization of care services you seek out or receive. To understand ex-post moral hazard, consider a situation where you are admitted to the hospital to be treated for an injury or acute event. Maybe you end up feeling well enough to go home after two nights, but because your insurance will cover up to three nights, you decide to stay the extra night. That additional utilization (that you presumably would not have paid for if you didn't have insurance) is due to ex-post moral hazard.

When moral hazard results in economic inefficiencies

Why do health economists and policy makers care? Because they are interested in "efficiency," which occurs when spending money on healthcare is in the best interests of individuals (and society as a whole). Or, said another way: money spent on healthcare is efficient if there’s nothing else you’d rather spend it on. Moral hazard may produce inefficient spending in the form of the additional healthcare services or procedures purchased that would not have been purchased without the benefit of insurance. In the hospital example above, the expenditure for the third night would be considered inefficient because you would not have been willing to spend your own money on it. You would have rather foregone the extra night and saved that money to spend on something else, if you were paying out of pocket.

The original theoretical basis for why this happens was stated in terms of price: specifically, having insurance resulted in the price for the consumer (patient) to drop to zero, and therefore the patient “over-consumed” healthcare services at this artificially low price. Physicians (who act as a trusted adviser regarding which services patients “purchase”) are thought to be vulnerable to moral hazard as well. Over-testing, over-screening, prescribing brand-name medications instead of cheaper generic versions, etc., are often attributed to moral hazard (as well fee-for-service reimbursement mechanisms…but that’s another topic for another time). So, what’s the fix? Well, if the price drop is ultimately responsible for the over-consumption, then if you raise the price for consumers you should theoretically reduce the inefficient consumption that is due to moral hazard. Cost-sharing policies such as co-pays and deductibles are the usual way this is done: with cost-sharing the consumer faces a price, even if it is not the full price. Maybe it’s for only the first $5,000 dollars spent, or maybe it’s for 20% of all services, or maybe it’s for only certain types of medications or services, or whatever an individual policy stipulates. When services are no longer free to patients, the argument goes, there will be less moral hazard and fewer inefficient healthcare expenditures.

Why it’s not that simple

Unfortunately, it’s more complicated than that. Not only are there nuances to the patient-provider relationship within the “transactions” of healthcare services, there are certain services where the increase in use due to moral hazard is actually a good thing!

Let’s first consider the patient-provider relationship. Patients seeking out healthcare services are not like consumers buying a car or hiring a landscaper - they are often operating with very limited knowledge or understanding of the services they may need (an economist might refer to this as “bounded rationality”). During a typical health encounter, the physician may make recommendations like, “I’d like to order a chest x-ray for you,” or “I think you should be on this medication,” or “I’d like to refer you to a specialist,” and the patient probably doesn’t have the training, knowledge, or even the time to be able to fully evaluate the value of those services, and therefore relies on the expertise of the physician when deciding what to do. That’s not to say that moral hazard doesn’t play a role. Say, for example, the patient learns that the recommended chest x-ray would cost them $300 out of pocket. That might influence how readily they agree to have it done…but then again, it might not. Given the limitations in the patient’s ability to fully evaluate the value of recommended services, it becomes harder to say how much of the choice to select that service is due to moral hazard, and therefore how much of it is inefficient.

For that matter, consider how limitations in patient knowledge and understanding could impact the efficiency of spending in our previous example of the three-night hospital stay. We can imagine circumstances under which the patient might feel that two nights is sufficient and only stays that third night because insurance paid for it. But, it may also be the case that the patient is unable to fully evaluate their health status because of limitations in their clinical knowledge and experience we pointed out above. Maybe, depending on the condition, leaving the hospital too early increases the risk of subsequent infections which would result in the need for additional care - and hence additional expenditures. Maybe empirical evidence indicates that three nights is the ideal stay for that condition and therefore the patient should be incentivized to stay for that long, regardless of what they would choose to do if they were paying for their care out of their own pocket. If that’s the case, then when the patient chooses to stay for the third night because it is covered by insurance, we have a situation where moral hazard results in efficient healthcare expenditures, because it was in their best interest to stay, even if they didn’t realize it.

And what about expensive procedures? Most people could not afford to pay for major surgery, extensive cancer therapies, or even many medications if they didn't have insurance, and therefore could not purchase them on their own, even if they desperately wanted to. Clearly, the fact that insurance allows many people to receive these services that are otherwise unaffordable does not represent inefficient spending. John Nyman published a theory several years ago that explores this in detail (he wrote a summary in Health Affairs in 2004); he suggests that in contrast to the original theory of health insurance, "people buy health insurance to obtain additional income when ill," and describes insurance as basically a redistribution of income from healthy individuals to those who require healthcare services. He correctly points out that nobody is going to choose to undergo heart surgery when it’s not necessary just because insurance makes it affordable, so a co-pay for that type of a service (as a means of reducing moral hazard) just doesn’t make sense.

Finally, let’s consider healthcare services that fall into the category of preventive care, where health insurance may promote additional care utilization that is beneficial to patients and society. Incentivizing someone to seek out preventive care (yearly physicals, flu shots, etc.) by fully covering that care is most certainly a GOOD thing, and yet we can be sure that if everyone had to pay for those things out of their own pocket they would utilize preventive care MUCH LESS OFTEN. (How many of you would go to the dentist twice a year if it wasn't covered?) This is especially true for those who are already suffering from a condition (e.g., hypertension, diabetes, etc.) that may increase their risk of adverse events or higher care utilization.

A final thought

Issues related to moral hazard are typically multidimensional and have different implications for different situations and types of care services. When you read an opinion piece or policy analysis that denounces the moral hazard that will be exacerbated if coverage is extended for certain conditions or if co-pays and deductibles are reduced, check a little more closely regarding what, exactly, is being proposed. It’s almost guaranteed to be more nuanced than the author is describing; take a critical look and apply a more comprehensive evaluation of the policy implications.