Moral Hazard and Co-pays

Now, on with the intro course.

I have mentioned Moral Hazard as the fear that people will buy insurance only after they get sick. Now let me introduce another way in which the term is used regarding health insurance. This is the idea that people will over-consume health care because somebody else is paying for it. Hey, it’s free, I’ll have the champagne! It is often argued that the way to contain medical costs is to make people pay more out of pocket.

Well, before we even think about the logic, that argument fails on the rather convincing criterion of being inconsistent with observable reality. As I have already indicated, Americans already pay more out of pocket for health care than people anywhere in the world, but nevertheless we spend more in total. In the real world, not the imagination of the ideologue, raising out of pocket costs absolutely does not result in lower medical expenditures. Insisting that it does is what’s called magical thinking: It must be true because I believe it. But it isn’t true. How can this be? What about economics 101, price elasticity of demand, and all that?

Well it ought to be obvious, I think. Just because my insurance would pay for me to have a coronary artery bypass graft, a PET scan, have three vertebrae fused, or a bowel resection doesn’t mean I’m going to run out and get them all. On the other hand, that really expensive stuff that drives much of medical spending is largely impervious to out-of-pocket cost. If your doctor says you need it, you’ll do it even if you have to take out a second mortgage. Yet less expensive procedures, which aren’t accompanied by desperation but might actually be cost effective or even cost saving, are price elastic, such as taking medication for high blood pressure.

My previous insurer, which happened to be Blue Cross/Blue Shield of Massachusetts, charges $250 for a colonoscopy in its standard plan. That's more than enough money, obviously, to discourage a lot of people from getting one. Every foregone colonoscopy saves them quite a bit of money, since the provider is probably charging them close to a grand. It means they can offer a lower premium compared to a hypothetical competitor that charged a more affordable co-pay, or none at all.

Now, it is difficult to imagine that anyone would go out of his or her way to get a colonoscopy that wasn't medically indicated just because it was cheap. We would only consider undergoing such an onerous experience because our doctor told us it was in our own best interest. The $250 can only make us refuse.

Some readers may dispute this, but it is generally accepted by the people who study these matters that screening colonoscopy, starting at age 50 and then at intervals depending on what is found the first time, is highly cost-effective from a social standpoint. It can actually prevent cancer from occurring in the first place, because the doctor removes pre-cancerous lesions during the procedure. That puts it way ahead of a mammogram. And it can detect cancers at an early stage when they are highly curable, whereas colon cancer detected after it becomes symptomatic is very bad news indeed.

So why doesn't the insurance company want me to have a colonoscopy? Because they figure, by the time I get cancer, I won't be their problem any more. I'll probably be on Medicare, actually, but even if I'm not there is a very good chance I will have changed jobs and be on a different private plan. (As indeed was the case.) So what is cost effective from the point of view of society as a whole is that there be no cost barrier to getting a colonoscopy; when it's indicated, people should do it, because the cost is well worth it and indeed, it might even save money in the long run. But that is not cost effective from the point of view of the insurance company, which doesn't want to pay for my colonoscopy on the pretty good bet that ultimately, they won't have to pay for my cancer.

Bottom line: Co-pays and deductibles do discourage people from using services or taking medications, but don't cause them to make those choices wisely, and can even result in higher costs in the long run. The way to trim waste is to manipulate provider incentives, not consumer incentives. Again, remember, what they taught you in Economics 101 was completely wrong.