Effect of Comprehensive insurance
Many countries are implementing
comprehensive medical insurance for their people to reduce financial strain on
low income people. This will lead to the reduction of spending or out of pocket
medical expenses for the households. I want to explore the effect of this
introduction of comprehensive health insurance on aggregate saving rate. I expect that with this introduction of health
insurance, the households will tend to save less which might be
counterproductive for the national economy.
Theoretical background and bibliography:
Households are generally risk
averse. They tend to keep in mind about future possible economic shocks and try
to prepare for it. Households can try to mitigate the negative economic shock
by precautionary saving, sending more members of the household into labor
market or by borrowing from different sources. But with the introduction of
comprehensive insurance, they can be certain to avoid negative financial shock
from sickness and will save less because of this certainty.
There is also income effect that
we need to take into consideration. Due to the introduction of comprehensive
health insurance, people will have more disposable income. The standard
life-cycle model predicts that increasing personal income will also increase aggregate
savings. The net impact on aggregate saving thus depends on which effect is dominant.
So, we need to consider these two effects to see the ultimate effect on
There is considerable literature
that provides evidence of a negative correlation between comprehensive health
insurance and saving. Kotlikoff (1989) in his paper “On the Contribution of
Economics to the Evaluation and Formation of Social Insurance Policy” showed
with a simulation that, when there is comprehensive insurance available, the
household savings is lowest and when agents must get their own insurance,
savings level is highest.
Shawn Kantor and Price Fishback
(1996) test whether the introduction of social insurance has led to a reduction
in private insurance purchases and precautionary saving by examining the
introduction of workers’ compensation. They find that the presence
of workers’ compensation at least partially crowded out private accident
insurance and led to a substantial reduction in precautionary saving.
Buchmueller and Robert G. Valletta (1999) found a strong negative effect of
husband’s health insurance on wives’ work hours, particularly in families with
children. Chung-Ming Kuan and Chien-Liang Chen (2003) finds that
comprehensive insurance has greater impact on the households with higher income
and those with retiring heads, especially on high savers in these groups.
Starr-McCluer (1996) conducted an
empirical finding which showed that US households who have health insurance
saved more than those who doesn’t have coverage, which is a violation with the
standard consumption–saving theory.
When comprehensive health insurance is introduced, the
households face two savings decisions or this could affect the households
saving decision in two ways:
i)Substitution effect or Precautionary motive and
When a comprehensive health insurance is introduced in an
economy, households face less uncertainty about their future medical expenses.
So, they can reduce their precautionary saving or specifically, the portion of
the precautionary saving that they thought would need to be spent on future
health issues. But, also there is an income effect. When households have health
insurance, they have more to spend compared to the case when they didn’t have
insurance. And, also, they would have to spend less in case of any medical
emergency. So, their income would also increase and they would have more
disposable income to spend.
In the end, the result will depend on the overall strength
of the two effects. If the substitution effect is strong, they will increase
savings after the introduction of comprehensive insurance and decrease savings
if the income effect is stronger.
The actual social insurance is usually followed by the
expectation of such. A government will announce a policy that will result in
the introduction of social insurance policy, starting from a specified date in
At the point of the announcement there is likely to be a
behavioral effect on the part of individuals who will be affected by this
The asset accumulation equation is:
= At + Yt + trt ? Mt ? Ct
Here, Mt= government expenses
trt= government transfers
Yt=Post tax income
The borrowing constraint:
+ Yt + trt ? M? Ct ? 0
housing saving rate:
The aggregate household
saving rate at any time t0, ASratet0 , can be
As there is no change in aggregate disposable income, we can
Proposition for the
The medium-term effect
of the introduction of social health insurance on the aggregate household
saving rate, is negative when the behavioral effect dominates, and ambiguous
when the combined effect of savings and disposable income dominates. When the savings
and disposable income dominates, the effect on the aggregate household saving
rate depends on the relative magnitudes of the increases in Aggregate savings
“AS” and disposable income, “yit”.
So, to observe an
increase in savings, we need to observe a very strong combined effect of
savings and disposable income
In the long run:
In the long run, it is expected that the behavioral effect
will be spread among the population or among most of the population. So, this
effect will become stronger eventually and the combined effect will most likely
be even smaller compared with the behavioral effect in the long run. So, it is
very likely that in the long run, savings will fall with the introduction of
social health insurance.