Co-Payments

Insurance companies frequently require their customers to pay part of their medical bills. A customer might, for example, have to pay the first $20 of a bill or 10 percent of the total amount. Co-payments, however, can never cause the customer to be as financially responsible as if he were paying all the bills himself.

You are deciding whether to buy good X for $100. Obviously, you will buy the good if it is worth more than $100 to you. Now assume that if you get good X, the insurance company will pay part of the cost, so the cost to you of good X is now lower than $100. This must necessarily make you more willing to buy good X. If the insurance company pays for 10, 30, or 90 percent of the cost, you are still more likely to get X when insured. By definition, health insurance lowers the price of medical services to the sick. The greater the co-payment, the less likely the customer is to buy the service. As long as the co-payment isn’t 100 percent, however, the individual’s insured state makes him more likely to buy medical services.

Which type of co-payment causes consumers to buy fewer medical services: (1) a fixed co-payment or (2) a percentage co-payment? Once you have made the fixed payment, it becomes a sunk cost and should rationally be ignored and thus will have no effect on inhibiting wasteful spending. In contrast, if you have to pay 10 percent on all bills, you always have some incentives to reduce costs.