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