The impact of adverse health events on consumption: Understanding the mediating effect of income transfers, wealth, and health insurance

Using data from the Panel Study of Income Dynamics for years 1999–2013, we investigate the impact of physical and mental illnesses on household consumption and financial status. In comparison to severe physical health problems, mental illnesses lead to larger decreases in labor income. Increases in public and private transfers following the onset of a mental illness do not completely offset the decline in labor income. Consequently, we find a significant decrease in consumption expenditures after the household head experiences a mental problem. On the other hand, public and private transfers and accumulated wealth offset the relatively smaller decline in labor income and enable households with severe physical problems to smooth their consumption. Health insurance helps to prevent larger drops in consumption after the onset of a mental health problem.