Moral hazard matters: measuring relative rates of underinsurance using threshold measures.

Health care spending in the United States has increased dramatically over the last few decades—averaging 3.7 percent real growth per year from 1995 to 2005—and rapid growth is predicted to continue (Congressional Budget Office 2008). In response to this growth, many employers are making changes to their health insurance plans to include more cost-sharing provisions, such as higher deductibles and coinsurance. Because of these trends, there is growing concern that merely having any health insurance is insufficient and that insured households are becoming less able to afford the cost of their medical care. That is, in addition to many households not having health insurance, many may be “underinsured.” In order to quantify the number of households that face difficulties in paying for medical expenses, researchers have defined various measures of underinsurance. Underinsurance is typically understood as health insurance failing to provide adequate protection against health care expenditures (e.g., see Bashshur, Smith, and Stiles 1993). Several measures of underinsurance have been adopted since there is no consensus on how to apply this concept. In pioneering work, Farley (1985) and Short and Banthin (1995) defined underinsurance by combining the risk of a high-expenditure illness and the adequacy of insurance coverage for this event. Others have defined underinsurance using the size of specific insurance benefits (e.g., annual deductible) relative to family income (Schoen et al. 2005) or the actuarial values of policies (Gabel et al. 2006). The most common underinsurance measure is a threshold measure, which indicates whether a household has spent a certain percentage or more of income on out-of-pocket health care expenditures (see Shearer 2000; Merlis 2002; Schoen et al. 2005; Banthin and Bernard 2006; Ziller, Coburn, and Yousefian 2006; Banthin, Cunningham, and Bernard 2008; Schoen et al. 2008; Collins et al. 2009;). Threshold measures of underinsurance are used because they are easy to compute given available data and are easy to explain. A commonly used threshold for working-age populations is 10 percent of household income. Of course, there are normative assumptions built into this measure just as in any threshold measure of well-being.1 Different thresholds can be applied to different populations, for example, households in poverty or elderly families. Regardless of the level of threshold used, or whether the same threshold is applied to all populations, threshold measures of underinsurance fail to take into account that households with less comprehensive coverage tend to consume less medical care than they would if they had better insurance, or alternatively, that generously insured households tend to consume more medical care than they would if they had less generous insurance. Economic theory (see Cutler and Zeckhauser 2000), nonexperimental studies (e.g., Newhouse and Phelps 1976; Bhattacharya and Vogt 1996;), and experimental studies (Manning et al. 1987) all find that health insurance expenditures respond positively to the generosity of health insurance; this responsiveness is referred to as “moral hazard.” Any threshold measure of underinsurance is a function of actual expenditures for out-of-pocket health care relative to household income. Coverage generosity affects out-of-pocket expenditures in two ways: directly—through coinsurance, deductibles, out-of-pocket spending limits, etc.—and indirectly—through the effect of moral hazard. The concept of underinsurance refers to the direct effect: less generous benefit designs will translate into higher out-of-pocket expenditures for a given level of total spending. However, because of the indirect effect, less generous insurance also will tend to decrease households' medical care utilization and expenditures through a “reverse” moral hazard effect. Therefore, a threshold measure of underinsurance will underestimate the extent to which households have less generous plans. Moreover, when comparing the rate of underinsurance across two populations, the one with less generous coverage will be less likely to have high out-of-pocket spending relative to income than they would in the absence of a moral hazard effect, causing an underestimate of the difference in underinsurance between the two groups. In this paper, we show that threshold measures of underinsurance typically will not accurately measure the degree of underinsurance in one population relative to another where insurance benefits vary and propose an adjusted threshold measure of underinsurance that takes into account moral hazard. To demonstrate this problem and how our proposed adjustment would work, we consider the specific case of estimating the difference in underinsurance rates between households who receive their insurance from small firms versus large firms.2 While the adjustment method we propose would apply to any threshold measure of underinsurance, we use the 10 percent threshold measure as our baseline case and test the sensitivity of our results using alternative definitions. We find that adjusting for moral hazard makes a noticeable difference in relative underinsurance rates. According to a 10 percent threshold measure of underinsurance, which does not account for moral hazard, the underinsurance rate among households whose policyholder is employed by a small firm is 90 percent of that among households whose policyholder is employed by a large firm. That is, despite substantial evidence that small-firm households tend to have less generous coverage, these households appear to have lower rates of underinsurance. We show, however, that this comparison is misleading because of the moral hazard effect. After adjusting for moral hazard, the underinsurance rate among small-firm households is 33 percent greater than that among large-firm households.