The Real Economics of the Health Insurance Market

By | February 15, 2010

Would the creation of a health insurance exchange benefit consumers? Recent research from Center investigators suggests that it would – by addressing an under-appreciated source of inefficiency in health insurance markets: the existence of Òsearch frictions.Ó In economics jargon, Òsearch frictionsÓ refer to the difficulties consumers face when purchasing complicated goods. In the market for health insurance, where plans vary along numerous dimensions, consumers find it hard to meaningfully compare all their options. As a result, high-priced plans can remain profitable even when similar lower-priced plans are available. In search forthcoming in the American Economic Review, Drs. James Rebitzer, Lowell Taylor (Carnegie Mellon), Mark Votruba, and Randall Cebul estimate that the presence of search frictions enable insurers to set average premiums for employer-based insurance about 30% above competitive levels. This results in excessive administrative and marketing costs for the insurers and also undermines insurersÕ incentive to efficiently finance care that could reduce future costs. By making comparison shopping easier, like Progressive insurance does in the car insurance market, a health insurance exchange would increase price competition among insurers. An earlier version of this work was published as a National Bureau of Economics Research working paper #14455.(posted 2/2010) hello