Optimal Prevention and Savings: How to Deal with Fatalism?

In this paper, we study the relationship between prevention and savings and analyze their socially optimal levels. In a first part, we analyze optimal decisions of primary prevention and savings when individuals face a health risk involving expenses that can not be covered by any insurance (private or public). We take into account the possibility for the individuals to underestimate or overestimate the health risk. To manage health risk, individuals have two possibilities: invest in primary prevention, in order to reduce the probability of the disease and/or save, in order to face the costs of the disease that are not covered by insurance. We show that the impact of wealth and interest rate on prevention and savings decisions strongly depends on the perceived substituability between health and wealth. In the second part of the paper, as prevention generates externalities, individuals’ optimal levels of prevention are lower than the socially optimal ones. In this context, we analyze social optimum and its decentralization by tax-financed government subsidies to prevention expenses.