I opened a copy of James Henderson’s 2012 Health Economics & Policy textbook today and saw a criticism of 3rd-party insurance payment illustrated by this example on page 7:
Spending Somebody Else’s Money
A Wall Street Journal article [by James P. Weaver, November 19, 1992] provides an interesting example of how spending someone else’s money distorts the decision-making process. A 70-year-old man suffering from a ruptured abdominal aortic aneurysm was brought to the hospital. After several weeks in the intensive care unit—with all the modern technology that goes with it—and a three-month stay in the hospital, the bill approached $275,000, none of which would be paid out-of-pocket by the patient. The man’s physician determined that his poor eating habits, caused by poorly fitting dentures, were contributing to his slow recovery. He requested that the hospital dentist perform the necessary adjustments. Later, the doctor discovered that the man had not allowed the dentist to adjust the dentures. When asked the reason, the man replied, “$75 is a lot of money.” It seems that Medicare would not pay for the adjustment, so it would have been an out-of-pocket expenditure for the patient. When you’re spending somebody else’s money, $275,000 does not seem like a lot. But when you are spending your own money, $75 is a lot. Our reliance on a third-party payment system is the major institutional feature that contributes to rising costs and increased spending. Cost-conscious consumers have little or no role in a system dominated by third-party payers.
The next page explains that this is called “moral hazard” which is defined as people consuming too much because of insurance. Moral hazard is an obsession among American economists, but think about the alternative in the above example. Without some sort of health insurance payment we would have to let him die.
In calling this an example of moral hazard, Henderson implicitly says that it is immoral to pay for the expensive treatments that saved a poor old man’s life. It is possible that $275,000 is too much money to spend saving someone’s life, but the textbook is not making that argument. It is using the mmutilitarian assumption that the primary moral consideration that determines the morality of helping the old man is how much money he has to spend. That is the idea that moral hazard is based upon.
To me, a bigger moral failure in this story than the alleged ‘moral hazard’ is the wastefulness of a system that does not spend a little money on prevention to prevent enormous bills and traumatic surgery. If our healthcare system were smart enough to spend $75 on denture adjustment, we might avoid $275,000 surgeries. This is one reason the US healthcare system is by far the most expensive in the world and gets mediocre results: we are penny wise and pound foolish. If moral hazard of insurance were a big problem, then countries with universal insurance would have much bigger health expenditures than the US, but they don’t. In Britain, the man’s insurance would have paid for a free denture adjustment and he would have had no need for the expensive surgery.
Even though most people don’t know what moral hazard is, it is an important concept because US policymakers are obsessed with combating it and that leads them to want to make the healthcare system crueler by increasing the costs that needy patients pay out of pocket because they hope to cut expensive healthcare services like the surgery in the above example by making it unaffordable to more people. Instead we should focus on ways to make the healthcare system more efficient by expanding the most cost effective healthcare like denture adjustments so that expensive surgeries can be avoided without cruelty.
Dentistry also gives evidence against the idea that the moral hazard of insurance has caused high price inflation in healthcare. Max Ehrenfreund at the Washington Post wrote that overall expenditures on dental work has been rising at about the same rate as medical expenditures and dentists’ incomes have been rising faster than doctor incomes. The government only provides dental insurance for about 9% of the US population.