The Generosity Paradox: When Less Generous Insurance Raises Spending

This paper shows that standard models of moral hazard predict a generosity paradox : less generous insurance can increase rather than decrease medical spending. Higher cost sharing makes it easier to reach the out-of-pocket maximum, where the marginal price is zero. Forward-looking consumers near that threshold therefore optimally increase their spending to reach the maximum. Using empirical estimates of the health need distribution and moral hazard responsiveness, I find that in many realistic scenarios, decreases in generosity lead to aggregate increases in spending and welfare losses. I discuss the practical implications of this for plan designers.