Asymmetric Information 589The United States offers some of the most sophisticated health and hospital
care in the world. However, a significant minority—some 50 million citizens
and legal residents as of 2009—did not have adequate health insurance.
Moreover, health care costs continue to rise. Health care expenditures now
constitute over 16 percent of U.S. gross domestic product.
Health insurance protects individuals and families against the financial risk
of illness. Paradoxically, however, the very benefit that insurance bestows is also
partly responsible for the escalation of health expenditures.^7 On average, such
insurance pays for between 80 and 90 percent of an individual’s major medical
expenses. With the patient’s share as low as 10 percent of true costs, patient and
physician have an incentive to spend too much (from a benefit-cost viewpoint)
on health care services. Insurance thus increases the demand for health care
services, which in turn results in higher insurance premiums and increased bur-
dens on government-sponsored insurance programs. This is the moral hazard.
What are the ways out of this dilemma? One approach is to make doctors
aware of the cost of the procedures and tests that they are recommending.
Traditionally, medical education has isolated doctors from considerations of cost.^8
However, with burgeoning health care costs becoming a national issue, medical
licensing standards since 2007 have required residency programs to teach doc-
tors about “cost awareness” and “risk-benefit analysis.” A second approach is to
monitor and regulate the choices of patient and physician. These efforts range
from promulgating voluntary standards of medical practice to controlling which
medical procedures in which circumstances the insurance will reimburse. These
practices can reduce medical expenditures but at the risk of compromising the dis-
cretion of physicians and patients. Since the mid-1990s, health insurers and health
maintenance organizations (HMOs) have aggressively pursued cost-containment
strategies, often sparking conflicts with physicians and patients.
A third response is to improve the incentivesfor cost control. For example,
insurers might reduce the rate of insurance coverage and make the patient pay
a greater percentage of the cost. Advocates of this approach argue that raising
patient payment rates to 20 to 30 percent would provide stronger incentives
for reduced expenditures and eliminate expenditures having low or uncertain
marginal benefits. For instance, Whole Foods Market, Inc. has adopted a pro-
gram in which employee premiums are low (zero for most workers), but the
deductible (the amount an employee must pay before the insurance kicks in)
is $1,500. Each year Whole Foods puts a fixed amount of money into a medical
account for each employee. If the employee does not use this money, it is carried(^7) College professors face a similar problem. Most professors have no idea how much a textbook
will cost students and so rarely take textbook costs into account. As a result, textbook publishers
are free to set unusually high prices for leading texts.
(^8) For a close analysis of health care insurance and health costs, see M. McClellan, “Reforming
Payments to Healthcare Providers: The Key to Slowing Healthcare Cost Growth While Improving
Quality?” Journal of Economic Perspectives25 (Spring 2011): 69–92.
Health
Insurance and
Medical Costs
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