Health insurance increases the demand for healthcare. Since the RAND Health Insurance Experiment in the 1970s this has been demonstrated in many contexts and many countries. From an economic point of view this fact raises the concern that individuals demand too much healthcare if insured, which generates a welfare loss to society. This so-called moral hazard effect arises because individuals demand healthcare that has less value to them than it costs to provide it. For that reason, modern health insurance plans include demand side cost-sharing instruments like deductibles and copayments. There is a large and growing literature analyzing the effects of these cost-sharing instruments on healthcare demand. Three issues have recently received increasing attention. First, cost-sharing instruments such as yearly deductibles combined with stop losses create nonlinear price schedules and dynamic incentives. This generates the question of whether patients understand the incentives and what price individuals use to determine their healthcare demand. Second, it appears implausible that patients know the benefits of healthcare (which is crucial for the moral hazard argument). If patients systematically underestimated these benefits they would demand too little healthcare without health insurance. Providing health insurance and increasing healthcare demand in this case may increase social welfare. Finally, what is the role of healthcare providers? They have been completely absent in the majority of the literature analyzing the demand for healthcare, but there is striking evidence that the physicians often determine large parts of healthcare spending.
In many countries of the world, consumers choose their health insurance coverage from a large menu of often complex options supplied by private insurance companies. Economic benefits of the wide choice of health insurance options depend on the extent to which the consumers are active, well informed, and sophisticated decision makers capable of choosing plans that are well-suited to their individual circumstances. There are many possible ways how consumers’ actual decision making in the health insurance domain can depart from the standard model of health insurance demand of a rational risk-averse consumer. For example, consumers can have inaccurate subjective beliefs about characteristics of alternative plans in their choice set or about the distribution of health expenditure risk because of cognitive or informational constraints; or they can prefer to rely on heuristics when the plan choice problem features a large number of options with complex cost-sharing design. The second decade of the 21st century has seen a burgeoning number of studies assessing the quality of consumer choices of health insurance, both in the lab and in the field, and financial and welfare consequences of poor choices in this context. These studies demonstrate that consumers often find it difficult to make efficient choices of private health insurance due to reasons such as inertia, misinformation, and the lack of basic insurance literacy. These findings challenge the conventional rationality assumptions of the standard economic model of insurance choice and call for policies that can enhance the quality of consumer choices in the health insurance domain.