On the design of optimal health insurance contracts under ex post moral hazard

We analyze the design of optimal medical insurance under ex post moral hazard, i.e., when illness severity cannot be observed by insurers and policyholders decide for themselves on their health expenditures. The trade-off between ex ante risk sharing and ex post incentive compatibility is analyzed in an optimal revelation mechanism under hidden information and risk aversion. The optimal contract provides partial insurance at the margin, with a deductible when insurers’ rates are affected by a positive loading, and it may also include an upper limit on coverage. The potential to audit the health state leads to an upper limit on out-of-pocket expenses.