A Life Cycle Analysis of the Effects of Medicare on Individual Health Incentives and Health Outcomes

Medicare is the largest health insurance program in the U.S. This paper analyzes the effects of Medicare on individual health incentives and outcomes resulting from the dynamic trade-off induced by insurance between moral hazard in health related choices and mortality risk. A life cycle human capital model of endogenous decisions about health insurance, medical utilization, alcohol consumption, smoking and exercise is estimated using panel data from the Health and Retirement Study. Model simulations imply that Medicare benefits elderly through insurance against medical expenditures, small improvements in health status and reduced mortality. However Medicare induces increased medical utilization, and small levels of moral hazard in alcohol consumption, smoking and exercise among elderly. Medicare also has a small effect in counteracting moral hazard in alcohol consumption, smoking and exercise for younger individuals by inducing self-protection. Overall, Medicare improves life time utility, with individuals willing to pay between $1,530.36 and $3,574.76 (in 1991 dollars) annually for its coverage. Additional simulations show that reforming Medicare by increasing the eligible age will lower insurance against medical expenditures, medical utilization, and health outcomes over the life cycle, and vice versa.