… The individual who has insurance which covers all costs demands medical care as though it had a zero price, but when he purchases insurance, he must take account of the positive cost of that care, as “translated” to him through the actuarially necessary premium. Hence, he may well not wish to purchase such insurance at the premium his behavior as a purchaser of insurance and as a demander of medical care under insurance makes necessary.

The presence of a “prisoners' dilemma” motivation makes this inconsistency inevitable. Each individual may well recognize that “excess” use of medical care makes the premium he must pay rise. No individual will be motivated to restrain his own use, however, since the incremental benefit to him for excess use is great, while the additional cost of his use is largely spread over other insurance holders, and so he bears only a tiny fraction of the cost of his use. It would be better for all insurance beneficiaries to restrain their use, but such a result is not forthcoming because the strategy of “restrain use” is dominated by that of “use excess care.”

It has been recognized in the insurance literature that medical insurance, by lowering the marginal cost of care to the individual, may increase usage; this characteristic has been termed “moral hazard.” Moral hazard is defined as “the intangible loss-producing propensities of the individual assured” [Dickerson, 1963, p. 463].