Charity Care, Risk Pooling, and the Decline in Private Health Insurance.

Over the past several decades health-care costs have increased substantially, and the share of the population with insurance coverage has decreased. Relative to GDP, medical care today accounts for 75 percent more of the economy than it did in 1980. At the same time, the share of the non-elderly population that is uninsured has increased by roughly 4 percentage points since 1987. To what extent is the increase in the cost of health insurance responsible for the decline in coverage? Individuals will purchase coverage if the utility of being insured exceeds that of being uninsured. Textbook economic theory suggests that rising medical expenditures ought to increase the utility of coverage because insurance mitigates risk. If the variability of spending rises as medical care costs increase, insurance becomes more valuable (Charles Phelps, 1997). The rising demand for pharmaceutical coverage following the rise in spending on pharmaceuticals is consistent with this model. In the textbook model, rising costs would be associated with falling coverage only if the cost increases were driven by increased administrative loads. Empirically, though, most medical spending is a result of increased quantities of care received, owing to technological changes in medicine, not greater administrative burden (Cutler and Mark McClellan, 2001). There are two extensions to the textbook model that can help explain the inverse relationship between premiums and insurance coverage. The first is the hypothesis that the value of new services is not sufficiently high to justify their costs, and thus some people rationally decline coverage when costs increase. Of course, if consumers had the option, they would exclude unvalued care from the insurance policy, but determining which care is valuable and which is not may be difficult, and contracting imperfections may make it difficult for individuals to purchase a plan that limits access to particular services. One type of unvalued care is traditional moral hazard: services are provided because of insurance but are worth less than they cost. Cutler (2004) shows that increased medical spending overall has bought care that is more than worth its value. But that does not imply that the differential growth of service use in some areas † Discussants: Amitabh Chandra, Dartmouth College; Ellen Meara, Harvard Medical School; Helen Levy, University of Chicago; Darius Lakdawalla, RAND Corporation.