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Nyman's model was developed by John A. Nyman beginning in 1999 and presents an alternative view of moral hazard in the context of private health insurance in the United States. Nyman is a professor of Economics at the University of Minnesota.
His theory proposes that private health insurance is purchased because consumers want to transfer income from their healthy state to their ill state where it is more valuable to them. Insurance takes advantage of the fact that not all purchasers of insurance become ill during the same contract year. For example, say that a certain healthcare procedure costs $100,000, but each person has only a 1 in 50,000 chance of becoming ill and needing that procedure in a year. The consumer is therefore able to purchase full coverage for that procedure for only $2, or a little more, because for every 1 person who becomes ill, there are 49,999 other consumers who pay into the insurance pool and remain healthy. Thus, insurance acts both to transfer $2 of the consumer's income to the consumer's ill state, and also to augment that income in that state.
The insurer transfers income from the healthy to the ill. This income transfer is typically accomplished by the insurer paying for the insured patient's care out of the pool of premiums that are paid to the insurer by both those who remain healthy and those who become ill. Moral hazard, the additional healthcare consumed because of insurance, can be decomposed into an efficient portion and an inefficient one, based on what the insured patient would have done with the income if they had been written a cashier's check for the insurance spending, instead of the insurer purchasing the healthcare for them. To the extent that the insured patient would have purchased more care with the additional income, this would represent the efficient portion of moral hazard. To the extent that the insured patient is responding to the lower effective price of healthcare , this would represent the inefficient portion of moral hazard.
For example, assume Elizabeth contracts breast cancer. Without insurance, assume she would purchase a mastectomy for $20,000. With insurance that pays for all her care, assume she would purchase a mastectomy for $20,000, a breast reconstruction for $20,000, plus 2 extra days in the hospital to recover for $4,000. Moral hazard is represented by the $20,000 breast reconstruction and $4,000 for 2 extra days in the hospital. To determine whether this moral hazard is efficient or inefficient, it would be necessary to present Elizabeth with a cashier's check for the income that came from the insurance pool to pay for her care and see what she would purchase. Assume that with her original income plus $44,000, she would purchase the $20,000 mastectomy and the $20,000 breast reconstruction, but not the 2 extra days in the hospital for $4,000. Because she could have purchased anything of her choosing with the additional $44,000 and chose to purchase the $20,000 breast reconstruction, we know that this portion of moral hazard is welfare increasing and efficient. That is, it was worth the $20,000 that was spent. Because she did not purchase the 2 extra days in the hospital to recover for $4,000, we know that this portion of moral hazard is welfare decreasing and was only purchased with her original insurance because the insurer was paying for all her care.