Dynamic Inefficiencies in an Employment-Based Health Insurance System: Theory and Evidence

We investigate the effects of the institutional settings of the U.S. health care system on individuals' life-cycle medical expenditures. We argue that health is a form of human capital that affects labor productivity, and that the employment-based health insurance system may lead to inefficient investment in individuals' health care. The reason is that labor turnover and frictions in the labor market prevent an employer-employee pair from capturing the entire surplus from investment in an employee's health. Thus, the pair underinvests in health capital, and this underinvestment increases medical expenditures during retirement. We provide extensive empirical evidence consistent with the comparative statics predictions of our model using two datasets, the Medical Expenditure Panel Survey (MEPS) and the Health and Retirement Study (HRS). The magnitude of our estimates suggests a significant degree of inefficiency in health investment in the U.S.