Tuesday, January 06, 2009

A clear failure of the financial bailout: mental health reform (and contract theory!)

One provision of the TARP financial bailout is a clear failure. (The rest requires macro, and I have to little expertise to judge, and doubt anyone does).

One feature that got slipped in is a provision that requires insurance companies to give equal coverage for mental health as they give to non-mental health. No one in the media has noted that this is very bad from the point of view of basic contract theory. Two recent npr stories highlight why.

1. On the media on the DSM
2. Leanord Lopate interviewing Norah Vincent on A Year in the Mental Institution

Health insurance is an example of a contract that deals with uncertainty and private information. On the point of uncertainty, there is much more uncertainty in mental health than there is other health. This is highlighted by the On the Media story which notes that one study finds that 84% of Manhatannites would be classified as having a mental illness under the DSM (the definitive book used to define mental disorders). They also note a study where a researcher had his healthy grad students hospitalized for schizophrenia but told them to act normally. It took them weeks before before they were allowed to go. In a follow up, hospitals were told to look for such grad students and identified dozens, though all the ones the hospitals thought were faking it, were in fact real patients.

Contract theory suggests that the higher uncertainty makes such diseases much more expensive to insure. And thus most rational individuals would choose to have more coverage for non-mental illness, and less coverage for mental illness. The new regulation would likely reduce overall health coverage in the market.

The second concern is the problem of moral hazard. The second npr story above interviews the writer of a recent book who was depressed herself, and later researched the treatment for depression by getting herself hospitalized at different psychiatric wards over the course of a year. She argues quite lucidly and fairly (to me anyway) that there is some room for individual effort involved in mental illness, and that more insurance could reduce the incentives for patients to get better themselves. Of course, there is also moral hazard in non-mental illness, such as eating right and controlling your cholesterol. However, insofar as moral hazard is worse for mental illness, than coverage is more costly, and therefore, people would optimally prefer less coverage for mental health. Again, the new regulation would reduce health coverage overall.
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