The Risk Protection Value of "Moral Hazard"

Health insurance lowers the out-of-pocket price of healthcare, and it is well-established that this leads to higher utilization of care. This manifestation of “moral hazard” is typically viewed as a social cost of insurance. Within a standard model, this paper shows that a consumer’s ability to change her behavior in response to insurance can also play a central role in the ability of insurance to protect her from risk. We provide a theoretical characterization of this channel and quantify its importance empirically. Under standard parameterizations and estimates in the literature, we find that insurance-induced healthcare utilization can account for more than half of the total value of risk protection derived from insurance. Preventing consumers from changing their behavior would lower healthcare spending, but also result in a major loss of risk protection, on-net reducing social welfare in some cases. Our results suggest that under-utilization of healthcare may thus be an equally important threat to welfare as over-utilization.