Health Insurance: Treatment vs. Compensation
2001/1: Asheim, G., Emblem, A.W., & T. Nilssen, The Department of Economics, Frisch Centre, Agder College & HERO. (PDF)
Like most types of insurance, health insurance offers compensation to the insured if the insured-against event occurs. Unlike most insurance, however, the compensation may take two distinctly different forms: The health insurance policy may either provide for coverage of medical expenditures (in part or in whole), or it may provide for a cash compensation of income loss caused by illness. This aspect of health insurance has interesting implications.
Asheim, Emblem and Nilssen view in this paper health insurance as a combined hedge against the two consequences of falling ill: treatment expenditures and loss in income. They discuss how an individual's ability when healthy affects her decision on whether to buy health insurance with treatment to full recovery if ill or with partial treatment combined with cash compensation for the resulting loss in income. The results show that a high-ability individual demands full recovery and is fully insured, while a low-ability individual demands partial treatment and cash compensation and is only partly insured.