The Welfare Implications of Health Insurance

We analyze the financial value of insurance when individuals have access to credit markets. Loans allow consumers to smooth shocks across time, decreasing the value of the smoothing (across states of the world) provided by insurance. We derive a simple formula for the incremental value of insurance and show how it depends on individual characteristics and the features of available loans. Our central contribution is to derive formulas for aggregate welfare that can be taken to data from typical studies of health insurance. We provide both exact formulas that can be taken to data on the distribution of medical expenditures and income and an approximate formula for aggregate data on medical expenditure. Using the Medical Expenditure Panel Survey we illustrate how the incremental value of insurance is decreasing with access to loans. For consumers in the sickest decile, access to a five-year loan decreases the incremental value of insurance by $338 (6%) on average and $3,433 (36%) for the poorest consumers. We also find that our approximate formula is a reasonable proxy for the exact one in our data. A central parameter of interest in health care policy is the value of health care insurance. Economic theory suggests health care insurance could improve both the health and the financial status of beneficiaries. Health care insurance lowers the price of medical care to beneficiaries on the margin and therefore may increase consumption of care. If increased care improves health, insurance may thereby improve health of beneficiaries. Moreover, health care insurance may be a more efficient means of raising capital for health care expenditures than alternatives such as current income, savings, or borrowing. Therefore, insurance may be able to reduce the overall cost of medical care – the price charged by the provider plus the cost of raising capital to pay that price – even for inframarginal consumption of care. While there is some dispute about the impact of insurance on health in the U.S., there is a consensus that it has positive financial impacts on beneficiaries. There is consistent evidence that health care insurance increases health care utilization (Buchmueller, Grumbach, Kronick, & Kahn, 2005), but there is disagreement about impact of that health care on health. Reviews by Freeman, Kadiyala, Bell, and Martin (2008) and Levy and Meltzer (2008) found well-designed but non-randomized studies showing a positive effect on health. However, both the RAND and the Oregon health insurance experiments reported that increased utilization from insurance had 1 University of Chicago. We thank Bartek Woda for excellent research assistance.