Integrating large health shocks into life-cycle models - modelling impacts of a cancer diagnosis

Most models on the life-cycle utilization of health care consider the expected development of an individual’s health. However, health shocks with significant impact (e.g. the onset of a chronic disease or life-threatening accidents) should not be averaged, as they can put the life-course onto a different trajectory. This paper presents an optimal-control framework incorporating a stochastic health shock with individuals allocating their resources to consumption and various types of health care over their life-cycle. We distinguish between general health care and shock-specific prevention, acute, and chronic care. We investigate the optimal decisions (on consumption, saving, and health care) made in anticipation and the optimal reaction to the shock depending on the timing of its arrival. Furthermore, we extend the value of life concept to the multidimensionality of health and the scope for a shock and illustrate our findings by calibrating the model to an individual facing a potential cancer diagnosis in the US. In so doing we also investigate the role of possible bias in the subjective expectation of a health shock.