Bounded Rationality, Moral Hazard, and the Case for Relative Value Health Insurance

Abstract

Now that the Supreme Court has upheld the constitutionality of the Patient Protection and Affordable Care Act (“PPACA”), access to medical care will sharply increase. But the new law will do little to reign in the rapidly increasing cost of medical care in the United States. Regulatory controls on prices or benefits, favored by some on the left, are political non-starters in today’s environment. Consumer directed health care (“CDHC”) proposals, which seek to provide patients with financial incentives to equate marginal costs and benefits at the point of treatment and is favored by many on the right, is infeasible because of the skewed distribution of health care expenses and patient bounded rationality. New approaches are desperately needed. This article proposes a government-facilitated but market-based approach to improvingefficiency in the market for medical care that I call “relative value health insurance.” The approach would enable even boundedly-rational patients to contract for the efficientlevel of health care services ex ante through their health insurance purchase decisions.The key to facilitating efficient contracting by boundedly-rational consumers is thecreative use of comparative effectiveness research (“CER”), which the PPACA funds at a significant level for the first time. CER should be used to create public ratings ofmedical treatments on a scale of 1-10 based on their relative value, taking into accountcosts and expected benefits. These relative value ratings would enable consumers tocontract with insurers for different levels of medical care at different prices, reflecting different cost-quality tradeoffs. After situating the concept of relative value health insurance within the context of ahealth insurance system that encourages overuse of resources and CDHC proposals that cannot mitigate the problem, the article describes the considerable benefits of relativevalue health insurance and considers some of the formidable obstacles to making it areality.