James Schneider  

Don't Nudge Me, Man! - Health Insurance Edition

Open Letter to President Wilde... Never reason from a price chan...

Nudge's chapter on Medicare Part D discussed the difficulties people had making optimal plan choices. The elderly often faced such a bewildering array of plans that it would have been almost impossible to minimize out-of-pocket expenses based on the specific medications that a person needed. On top of this, millions of poor people were automatically enrolled into the program without making any plan choice at all. Instead of the government choosing the best plan based on a person's drug history, most of these people were randomly assigned a plan. Thaler and Sunstein strongly disapproved of random assignment: "It seems somewhere between callous and irresponsible to assign plans without even looking at people's specific needs."

Although the discussion in Nudge was specifically about Medicare Part D, it probably reinforced the general idea that minimizing out-of-pocket medical expenses is a desirable social goal. However, insurance markets are often a bit trickier than this. First, insurers set premiums based on the expected claims. If people made perfect plan choices it would increase insurance claims, which would increase premiums in the subsequent years. For insured plans, premiums will increase more than claims because of premium taxes. Another problem is that insureds will often get expensive care with little value if the out-of-pocket expense is too low. (Reducing this type of waste is one of the arguments for the tax on Cadillac plans that starts in 2018.)

Benjamin Handel's recent AER paper illustrates how nudging people to make better choices can also be harmful due to increased adverse selection. He studied the data of a specific large firm where employees have a selection of plans to choose from. Three of the plans were PPO plans that shared the same network of doctors and covered the same services. This means that the decision of whether or not to switch between these plans was a strictly financial one. Employees showed a lot of inertia in their plan choices. An extreme example of inertia occurred when the employee contributions were increased for the low deductible plan. For 559 of the employees with this plan, switching to a plan with a higher deductible would have saved money no matter what their medical costs were. Yet only 11 percent of the employees facing this situation switched plans.

Would a nudge to make better choices help employees? Handel models what would have happened at this firm if employees showed less inertia. If employees did a better job optimizing their plan choices, the plan with the lower deductible would have attracted sicker employees. This would have caused the insurer to eventually increase the premiums of the low deductible plan to the point that healthy employees would have avoided it. This hurts employees that are healthy but risk adverse. In aggregate, reducing inertia would have decreased the welfare of the group's employees.

Although many economists are skeptical of employer-based insurance, it often does pretty well on Nudge's criteria for choice architecture. Employees do not face an endless selection of plan choices. Instead, larger employers frequently offer a small selection of plans that will accommodate a variety of risk preferences. Employers have an interest in negotiating a good deal on behalf of their employees: insurance is, is after all, an important part of employee compensation. However, larger employers do not have an interest in maximizing adverse selection since they are aware that higher claims this year will only lead to higher premiums next year.

I'm an actuary for an insurance company. My employer sells group insurance but not health insurance.

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COMMENTS (4 to date)
AS writes:

There's often a transaction cost to changing your health care plan, requiring one to mail paperwork to a bureaucracy for processing that can take several weeks. This can be a pain, so most people avoid it and leave things be. If health insurance wasn't so large and bureaucratic, but more nimble and competitive, transaction costs might be lower and hence allocations more efficient.

Comparing health insurance plans can also be complicated. There are many variables, and it is not always obvious which plan is best. Contrast to buying any other kind of insurance, e.g. car insurance. There are fewer variables and the insurance itself is invoked less often because it's reserved for catastrophic events, not routine expenses. Health insurance has gotten so complicated that most insurees don't even know the full details of their plan: which procedures are covered, etc. And if they ask their doctor, he doesn't know, because it's all determined by the insurance and they can't easily look it up. So the patient has to either dig through a 100-page manual detailing their plan, or call customer service and wait on hold for 30 minutes. The bureaucracy is simply infuriating.

Health insurance has just gotten too complicated and bureaucratic that it is going to be rife with inefficiencies by nature of bureaucracy. This shouldn't be a surprise to anyone. It scarcely resembles other forms of insurance which are less regulated. Adding a top-down nudge or another regulation will only complicate health care insurance more. The whole system needs to just be deregulated and let entrepreneurs sort it out in the free market.

magilson writes:

For 2014's enrollment I had to choose between the three plans my employer offered and the four plans my spouse's offered. Combine that with the permutations that come from a dependant and I had 28 possible selections. Then I calculated the least risk (cost) exposure and highest risk (cost) exposure of each scenario and then compared. But then you have to run a few additional scenarios to decide on contribution rates and the effects of having isolated contribution accounts that cannot be used to pay for another spouse/dependant.

There were a lot of permutations. Luckily I enjoy that kind of analysis. But I spent about 18 hours going over the details of all the plans and creating this spreadsheet. Not to mention my spouse and I had to have several discussions to review the resulting chosen plan's new "rules" as compared to the old rules.

When an economist declares that someone is making an inefficient decision I always think to myself that obviously that economist has too heavily discounted the "administrative" cost of all this background stuff. Or maybe they ignored it.

Now 99% of my friends suggested this was why we should Just Have Single Payer. But that always strikes me as a Not Adult reaction to a challenging problem. Because almost all of my friends are also simply doing a "what will this do to my monthly income" type calculation only because they're so accustomed to thinking in terms of their mortgage, car, and student loan payments instead of actually thinking.

Eric Falkenstein writes:

Unfortunately, one of the main goals of health policy is redistribution, which creates all sorts of inefficiencies and inconsistencies. Each problem generates a new patch, then a new problem.

It would be nice if we just gave poor people lump sums and then design efficient policies on top of that in my opinion, but I think that's not an equilibrium; there's more support for redistribution when it's done indirectly, so that's how it's done.

Zachary Bartsch writes:

Near the end of the 4th paragraph, you say "Risk Adverse". I think that you meant "Risk Averse".

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