Insurance-Induced Moral Hazard: A Dynamic Model of Within-Year Medical Care Decision Making Under Uncertainty

Existing studies estimate health insurance-induced increases in medical care expenditure by examining medical care decisions that are aggregated to the annual level. Using employer-employee matched data from the Medical Expenditure Panel Survey, I quantify the moral hazard effect of insurance on medical care expenditure by estimating a dynamic model of within-year medical care consumption that allows for insurance selection, endogenous health transitions, and individual uncertainty about medical care prices in an environment where insurance has non-linear cost-sharing features. The results suggest that the additional consumption induced by moral hazard amounts to 53.1 percent, on average, of total annual medical care expenditure when insured. In order to understand the relationship between the dynamic features of the model and the estimated moral hazard effects, I estimate a second model that is representative of the annual decision-making models found in the literature. The within-year decision-making model produces a moral hazard effect that is significantly different, and generally larger, than the alternative model. To illustrate the importance of the within-year decision-making model, I quantify the welfare and spending implications of health insurance alternative sets with more and less generous options.