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Analysing the Effects of Insuring Health Risks: On the Trade-off between Short-Run Insurance Benefits versus Long-Run Incentive Costs

Harold Cole, Soojin Kim and Dirk Krueger

Review of Economic Studies, 2019, vol. 86, issue 3, 1123-1169

Abstract: This article quantitatively evaluates the trade-off between the provision of health-related social insurance and the incentives to maintain good health through costly investments. To do so, we construct and estimate a dynamic model of health investments and health insurance in which the cross-sectional health distribution evolves endogenously and is shaped by labour market and health insurance policies. A no wage discrimination law in the labour market limits the extent to which wages can depend on the health status of a worker, and a no prior conditions law outlaws higher insurance premia for individuals with worse health status. In the model, the static gains from better insurance against poor health induced by these policies are traded off against their adverse dynamic incentive effects on household efforts to lead a healthy life. In our quantitative analysis, we find that it is optimal to insure 80% of labour market-related income risk (70% if a no prior conditions law is also present). Providing full insurance is strongly suboptimal, however, since at high levels of consumption insurance, the negative dynamic incentive effects on health effort and thus the population health distribution in the long run start to dominate the short-run consumption insurance gains.

Keywords: Health risks; Social insurance; Health effort choices (search for similar items in EconPapers)
JEL-codes: E61 H31 I18 (search for similar items in EconPapers)
Date: 2019
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Review of Economic Studies is currently edited by Thomas Chaney, Andrea Galeotti, Bård Harstad, Nir Jaimovich, Kurt Mitman, Francesca Molinari, Katrine Loken and Elias Papaioannou

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