Reconsidering the Moral Hazard-Risk Avoidance Tradeoff

Publication Authors:
Newhouse, J.P.

The received model for optimal demand-side cost sharing trades off moral hazard and risk avoidance. This model appears to lie behind recent increases in initial cost sharing, such as those embodied in Health Savings Accounts and Health Reimbursement Accounts. At the same time there is evidence that lower cost sharing for certain drugs can reduce future total health care costs and/or improve future health, and this may be true of other medical services as well. To the degree that individuals remain in the same common insurance pool, lower cost sharing that induces increases in certain services that reduce total costs, including future costs, represents a classic case for a subsidy and will minimize an employer's labor costs. Even if total costs increase, the value of a change in health could increase more. In that case such a subsidy is consistent with recent work in behavioral economics for those with self-control problems.


(October 2006)

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