Why Insurers May Want to Keep Customers in the Dark
Here is Austin Frakt, discussing a new paper by Benjamin Handel:
The difficulty consumers face in appreciating the value of plans and the resistance they exhibit in plan switching has a risk pooling effect. Think of it this way, if everyone could pick the plan that minimizes their cost, sicker individuals would end up in generous plans with higher premiums and healthier individuals in less generous plans with lower premiums. This is adverse (favorable) selection into the more (less) generous plans. That consumers don’t perfectly identify their costs under each plan and have status quo bias (inertia) undoes some of this selection.
I have long known that there is a lot of inertia under managed competition. For example, only a small percentage of federal employees switch plans every year. Of course, insurers could encourage more switching by explaining more clearly to those with health problems how they could gain financially by switching to a more generous plan. But why should they? The consumers gain is the health plan’s loss.
This is yet another way of understanding the effects of perverse incentives created by artificial health insurance markets.
Sometimes it’s just easier to pay the inflated premium and tell yourself you’ll look for a new insurance company next year.
Definitely, and that’s why behavioral economist argue that people don’t act rationally, because subconscious bias is built into intuition, so that prohibits people from acting completely logically/rationally in achieving the optimum result in a situation regarding opportunity cost.
Hmmmm. Maybe it is the economists who aren’t thinking rationally. Human beings are not just calculators crunching numbers. We need to consider ALL the costs. Some of those costs include the pain involved in shopping for new coverage, learning the new benefits, finding new care givers, figuring out how to file claims in the new policy. So what if it costs a little more to avoid all that? If we are content with what we have, why should an economist second-guess our decision? God save us from control freaks.
Greg:
I agree about the hassles and the time involved in switching policies.
But the statistics generally show that whether in the group or individual market, people hold on to their insurers 3-5 years. That means, every 3-5 years, an insurer must replace its entire customer base! Can you imagine how costly that is?
Don Levit
Although you’re not making this argument, I’ve heard people condemn the entire field of economics, claiming economics assumes rationality and people obviously are not rational. Yet when I was in school, it was explained by Herbert Simon’s theory of bounded rationality. That is, people act rationally within the bounds of their own priorities, preferences and other biases.
I’ve been guilty of look too long for the best deal – apparently receiving positive utility by the mere search or knowledge I got a good deal. I suspect a certain percentage of Groupon’s business is based on people buying something they would not otherwise buy because they like getting a good deal. On other occasions, I’ve paid a price I thought too high merely because I wasn’t willing to search for a better one.
I like economics (and economists) a lot, but it is only one aspect of understanding. They often get it backwards. It is scary how often I hear economists look at how reality doesn’t match their models and conclude there is something wrong with the reality. No, there is something wrong with their models.
I think we’re talking about two different things here. All purchases include search and switching costs. Business strategy 101 is to reduce your prospects’ search costs and increase their switching costs.
This is true whether you’re selling Apple Macs (computers) or Mackintosh apples (fruit). I use this example to demonstrate that even items discussed as commodities in undergraduate economics lectures can be differentiated to increase customers’ switching costs (i.e. increase their loyalty to Mackintosh versus Granny Smith versus Gala, etc., apples.
However, insurance markets are worse. In ordinary markets for goods and services, the customer has an incentive to hide his reserve price but he has no incentive to hide his need. The vendor wants to find the customers who need his product or service the most.
In insurance, the customer has every incentive to hide his need because he knows the insurer wants to sell to the customer who needs his product the least.
So the insurer is not interested in lowering prospects’ search costs. I believe it’s Greg Scandlen who told me the quip about the health insurer who is happy to take all applicants without underwriting.
Unfortunately, the carrier has no phone or website and is on the 10th floor of a building with no elevator!
“the quip about the health insurer”
Yes, and then there was the Dilbert toon about Dogbert – who had just been awarded a contract to operate the call center for a major insurance company.
After the award was made, an executive asked Dogbert “your price was by far the lowest – but how can you provide the service with only 2 employees?”
Dogbert answered “Call me.”
The evidence is new, but the idea goes back to Akerlof and even Arrow. This explains why nobody can understand their policy. And government demanding that insurers write policies in plain English are doomed to fail.
This also explains why insurance should be used rarely and only where the significant dead-weight costs of insurance are outweighed by its benefits in catastrophic situations.
This is definitely true, insurance has become this service that “has” to be used at all times. In fact, I would argue that insurance in and of itself provides a disincentive to save for emergencies and fiscal responsibility in general.
Insurance that has to be used all of the time and by everyone, is just plain useless and benefits only the provider.
I’ve heard critics argue insurer EOBs are intentionally confusing. That doesn’t make sense. Each caveat in an EOB is there for a reason and is a precise positive or negative transfer of risk from insured to insurer. The only people who understand the EOB may be the actuaries. But they’re the one who priced the policy with those caveats — which were priced that way for a reason. Get an HSA and you’ll have more control over what benefits are included — because you will be the one making that decision.
“Of course, insurers could encourage more switching by explaining more clearly to those with health problems how they could gain financially by switching to a more generous plan. But why should they? The consumers gain is the health plan’s loss.”
It would make sense that insurance companies would want to keep customers in the dark, because there is a very fine line in business ethics that is very blurred in today’s society.
I would say that they definitely have an incentive, because if they know all of the aspects of their plan they can “shop” their insurance substantially easier.
Good point.
That is the negative motivation behind pay-as-you-go policies, in which policyholders are unable to build reserves. Each year is a new ball game, so one is encouraged to seek out lower premiums for similar coverage.
What is needed is policies which encourage all- healthy and sick – to stay on for the long haul. National Prosperity Life and Health will provide such a patented policy in the self-insured market before year end and in the fully insured market in Texas in 2014.
Don Levit
“This is yet another way of understanding the effects of perverse incentives created by artificial health insurance markets.”
wow, and Obama-care creates an entirely new market full of those perverse incentives.
The less you know, they easier it is for your insurance provider to steal from you.
True. Ignorance is what is keeping a lot of these companies alive.
“consumers don’t perfectly identify their costs under each plan and have status quo bias (inertia) undoes some of this selection.”
There’s even more, and it’s not always about not perfectly identifying costs.
People are less willing to change when they feel they are not in good health. That’s one reason why the “old” plan tends to be the one suffering adverse selection when an employer adds a “new” plan option.
It’s natural for people who are less healthy to have a greater reluctance to change insurance plans. Their physicians know their medical histories and they prefer not to change insurance if it means changing their physicians – even if they can save some money. This preference is understandable and is not necessarily based on individuals’ failure to identify their own costs.
Of course it is also true that most people don’t understand their policy – and they admit it. Many may suspect a new policy can offer them lower cost only because it has lesser benefits in some obscure, fine-print way. Others may fear they will accidentally lose a benefit of real value, and/or be cheated, if they change insurance. The less healthy they feel they are, the more this particular worry enters the decision. Ironically, an insurance company’s effort to persuade these people to change plans may only increase their resistance. This resistance also does not seem motivated by failing to identify one’s own costs.
This is why the Federal Employees’ Health Benefits plan arrangement is/was so unstable.
In the late 80s early 90s standard indemnity plans fled, the plan had to move to once a year open season enrollment, and choice is lousy in a number of areas.
This is one of the strategies of companies to create more income for the insurance industry. It’s unfair but what can people do, they are the capitalist and we’re just the consumers. But I’m not giving up on planning for my future and perhaps I’ll just purchase combination products like life insurance and long term care insurance. I’ve been reading this http://www.ltcoptions.com/learn-the-basics/ and I think purchasing hybrid products can give me a generous coverage but without blowing my budget. People should continue planning for long term care and just take matters into their own hands and take advantage of what these insurance companies have to offer.