Value Based Cost Sharing Meets the Theory of Moral Hazard: Medical Effectiveness in Insurance Benefits Design

26 Pages Posted: 27 Jun 2007 Last revised: 24 Aug 2010

See all articles by Mark V. Pauly

Mark V. Pauly

University of Pennsylvania - Health Care Systems Department; National Bureau of Economic Research (NBER)

Fredric E. Blavin

University of Pennsylvania - The Wharton School

Date Written: April 2007

Abstract

The conventional theory of optimal coinsurance rates in health insurance in the presence of moral hazard indicates that, in situations of equal risk characteristics, coinsurance should vary if the price-responsiveness or price-elasticity of demand for different medical services varies, and should be larger for the more price responsive services. An alternative theory called "value-based cost sharing" indicates that coinsurance should be lower for services with higher (marginal) benefits relative to costs. This paper reconciles the two views. It shows that, if patient demands are based on correct information on benefits and costs, the conclusion of the conventional view is identical to the conclusion from the value-based approach. If patient demands differ from correct demands, it is shown that optimal coinsurance depends both on the extent and direction of information imperfection and on price-responsiveness or price elasticity. The paper also shows, as an alternative to adjusting coinsurance to deal with information imperfection, that providing better information which affects patient demands can be superior if uninformed patient demands exceed informed patient demands, but value based cost sharing can be superior to providing information (even if the cost of information is minimal) when patient demands fall short of informed demands. An extended numerical example illustrates these points.

Suggested Citation

Pauly, Mark V. and Blavin, Fredric E., Value Based Cost Sharing Meets the Theory of Moral Hazard: Medical Effectiveness in Insurance Benefits Design (April 2007). NBER Working Paper No. w13044, Available at SSRN: https://ssrn.com/abstract=986894

Mark V. Pauly (Contact Author)

University of Pennsylvania - Health Care Systems Department ( email )

3641 Locust Walk
208 Colonial Penn Center
Philadelphia, PA 19104-6358
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Fredric E. Blavin

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

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