Moral Hazard: Case Study

Moral hazard refers to the notion that a party that is insulated from risk will behave differently from how it would behave if it had full exposure to the risk. Whenever an individual or organization does not bear full responsibility for its actions, the party tends to behave in a more reckless manner than it otherwise would, and moral hazard arises. Concerning moral hazard and health insurance, the concept would predict that healthy insurance coverage would produce wasteful and risky behavior on the part of the policyholder because he/she does not bear the full financial consequences of his/her actions. Primarily an economic theory, moral hazard is often cited as one of the reasons why health insurance premiums continue to rise as coverage becomes more compulsory. In this post, we will seek to illustrate the notion of moral hazard as it related to health insurance with the presentation of a case study.

A Case Study: Erasing Incentives

Troy Britt, a 46-year-old production line worker, has an excellent HMO plan through his employer. Because of his modest income, Troy is normally very frugal and budgets his money carefully. However, health care costs him little to no money, as he has $0 co-pays for office visits and $5-$10 co-pays for most prescription medications. As a result, he usually doesn't think twice about visiting his doctor when the need arises, which is a positive consequence of his insurance coverage. On the other hand, Troy's lack of hesitation in consuming medical care is also where the issue of moral hazard arises. Lulled into complacency by the security of his plan, Troy gives little thought to how his sedentary lifestyle and poor diet impact his wellbeing. He never exercises and has a job that requires virtually no physical exertion. Nutritionally, he consumes large amounts of fat, cholesterol, and sodium and avoids high-fiber foods like fruits and vegetables. Though he is aware of the health risks of his lifestyle, he rationalizes his behavior with the belief that his doctor can fix any damage he does while his insurer foots the bill. During his last check-up, Troy's doctor informed him that he has arterial occlusion, high cholesterol, and high blood pressure. His genetic predisposition for heart disease also concerns his physician, who admonishes Troy to make lifestyle changes immediately. At the end of the visit, his physician prescribed him two medications: Lipitor for high cholesterol and Lopressor HCT for hypertension. Because it is much easier to pop a nearly free pill than join a gym, lose weight, or eat whole foods, Troy takes his medication regularly and visits his doctor more frequently for med checks. Troy could easily discontinue the medication if he were to change his diet and exercise habits substantially, but he has no financial incentive to do so. To underscore the costs of moral hazard, here is a list of just a few of the financial incentives Troy would have if he could not count on an insurer to pay for his poor choices:

• Assuming Troy shops at a discount warehouse, a two-month supply of 40-mg Lipitor would cost just under $200.
• A one-month supply of 50-mg Lopressor HCT costs approximately $80
• Bypass surgeries to remedy occluded arteries range in price from $25,000-$75,000