Modeling health shocks

Freiberger, M., Kuhn, M., & Wrzaczek, S. (2023). Modeling health shocks. IIASA Working Paper. Laxenburg, Austria: WP-23-002

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Abstract

Most of the models on the life-cycle utilization of health care assume that individuals are able to foresee the development of their health perfectly. However, health shocks with significant impact (e.g. severe life-threatening conditions, the onset of chronic disease or accidents) should not be averaged into a mean value, as they have the potential to put the life-course onto a different trajectory. In this paper, we introduce a dynamic optimal control framework incorporating a stochastic health shock with individuals allocating their resources to consumption and different kinds of health care over their life-cycle. We distinguish between general health care and shock specific p revention, a cute and chronic care. This set-up enables us to analyse how the health risk shapes individual behaviour with respect to the different types of health care and how health shocks change the trajectories of consumption and savings. Newly developed transformation techniques allow us to investigate the optimal decisions made in anticipation of a potential health shock and the optimal reaction to all possible shock scenarios. We are able to obtain analytic expressions for the consumption and health care utilization profiles before and after the shock and identify the driving forces. Furthermore, we extend the value of life concept to other aspects of individual health. Finally, we illustrate our findings by calculating a numerical solution calibrated to an individual facing a potential cancer diagnosis in the US.

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