In this week’s lecture, I introduced the RAND health insurance experiment conducted in the 1970s. In this experiment, a total of 2000 families consisting of 5800 persons have been randomly selected and enrolled in one of five health insurance plans for 3-5 years. The five plans were: free care (no co-insurance); 25% co-insurance; 50% co-insurance; 95% co-insurance; and a deductible of $150/person, or $450/family that applied to outpatient care only. 

Your assignment for this week is:

Step 1: Read this report that summarizes the RAND experiment findings. Link:   Specifically, focus on the background section (page 2), and the lessons learned (page 3-6). 

Step 2: Answer the following two questions. 

Question 1: 

In Table 1, Column 3 shows that outpatient expenditures are highly responsive to co-insurance rate, which is what we would expect based on the insurance moral hazard hypothesis. With a 25% co-insurance rate, outpatient expenditures are already about 25% lower than with no-coinsurance. Moving from a 25% to a 95% co-insurance rate lowers spending by another 22%. The deductible plan outcome looks similar to that for the 50% co-insurance rate. However, Column 6 in Table 1 shows that the relationship between co-insurance and inpatient expenditure is less clear. It suggests that the extent of insurance moral hazard for inpatient care utilization is less significant. 

Discuss the potential explanations for this finding: why are outpatient care expenditures more responsive to co-insurance rate than inpatient care expenditures? In other words, why is insurance moral hazard more severe among outpatient care, compared with inpatient care? (Hint: think about the role of physicians during inpatient vs. outpatient care.)

Question 2: The National Health Insurance debates of early 1970s focused attention on whether patient cost-sharing could drive down cost (Wiki link: leading Congress to authorize one of the most expensive research projects of all time, the RAND experiment. The goal of the RAND experiment is to learn as much as possible about demand elasticities (i.e., the impact of cost-sharing on the demand for medical care). 

Why do you think an experiment was needed to learn about demand elasticities? Why couldn’t we just use what we observe in real-world situations to infer demand elasticities? For example, if we observe people enrolled in “gold plans” (more generous in terms of coverage) spend more than people enrolled in “silver plans” (less generous in terms of coverage), why can’t we use the difference in their expenditures as evidence of insurance moral hazard and infer demand elasticities? (Hint: think about “adverse selection” we learned from last week.)