Moral Hazard: It’s the Supply Side, Stupid!

Abstract

In health care markets, moral hazard is conventionally viewed as a demand-side phenomenon in which insurance causes patients to use more care because it reduces the price they have to pay for care. However, demand-side moral hazard cannot explain why U.S. per capita health care costs are much higher than those of countries with universal coverage and lower out-of-pocket charges. Instead, blame rests with a phenomenon that may be called supply-side moral hazard, which occurs when third-party payment removes the constraints the demand curve would otherwise exert over the prices providers charge, and the quantity of expensive services they can sell. Public institutions are better positioned than private entities to address supply-side moral hazard. This helps explain why the other wealthy democracies—both those with single-payer systems, like Canada, and those with multipayer systems and all-payer procedures for setting provider rates, like Germany and Switzerland—spend much less per capita than the United States. Although managed care achieved some success in controlling U.S. provider prices in the 1990s, in the longer term, it motivated increasing market concentration among providers, which vitiated cost control. Furthermore, managed care exacerbates inequity and complexity, problems that public price regulation avoids.