Search Costs in the Health Insurance Market

The current health insurance market is broadly split between policies purchased by groups and those purchased by individuals.  Both markets have been faulted for inefficiencies which often leave buyers not choosing the policy with the best combination of price and benefits.  In a typically esoteric and quantitative economics paper published by the National Bureau of Economics, researchers explore the characteristics and costs of the health insurance market.   (NBER Paper) The paper especially focuses on search frictions, a somewhat arcane term that refers to the inability of purchasers to easily sift through all available choices and match their needs with the policies available.

In essence, because of this matching difficulty, insurers can charge higher prices and earn greater profits than they otherwise could and they will use the extra revenue on marketing activities to acquire more customers, which feeds the cycle.  Some of these marketing dollars are commissions to agents, who because they are paid by the insurers may not always recommend the best policy for the purchaser.   The researchers calculate that the effect of these search frictions is to transfer about $34.4 billion from consumers to insurers in 1997.  (No explanation is given for using such a dated year, but the cost probably is much higher today.)  In other words, the nation’s health insurance bill could be at least about $35 billion less if the market functioned better.  The authors go on to suggest that having a public plan option would lessen some of these distortions.

At this point it is unclear whether the PPACA will survive til the exchange implementation date of 2014 and whether it does or not, how many states will sponsor exchanges.  A well-conceived and regulated exchange can simplify insurance choices, particularly for individuals and smaller groups, often by standardizing policies so that the price/benefits equation is easier to understand.  Larger groups generally have the resources and market appeal to arrange for good, often customized, benefits at a reasonable price and likely will not need the exchanges.  Whether you are a fan of the current reform or not, exchanges seem like a good development that will encourage better competition while getting consumers a better price.  A public plan option is a whole different animal and we would think that we have seen enough from Medicare and Medicaid to know that aside from their ability to dictate provider payments there is nothing in either program that suggests good administration or the creation of efficiencies or improvements in the quality of care.