Consumer demand for health insurance.

• Author: Buchmueller, Thomas C.
• Position: Research Summaries

Since the early 1990s, prominent proposals for health insurance reform have focused on increasing consumer choice and competition among integrated health plans. Under "managed competition" models, consumers choose from a menu of health plans on the basis of price and quality. Proponents of these market-oriented plans argue that, in such a system, consumers will sort themselves into lower cost, higher quality plans; this pressure by consumers will provide strong incentives to health plans and their affiliated providers to control costs and increase quality in order to compete for enrollment. The Clinton administration's Health Security Act and the "premium support" proposals for reforming Medicare are variants of the managed competition approach. Although a "managed competition" model has yet to be adopted as national policy, many large employers organize their health benefits programs according to the same basic principles. Research on the behavior of employees and retirees in these employer programs provides a useful laboratory for the role of price and quality in consumer health insurance decisions.

One distinct problem for market-oriented solutions to health insurance is that, when consumers are offered a choice of health insurance options, the healthy (less risky) consumers may sort themselves into certain plans and the more risky consumers into others. Consequently, some plans will attract a disproportionate share of less costly low risk consumers, while others will attractive older, sicker consumers who are more costly to insure. This "risk selection," in turn, is influenced in part by the rules concerning how insurers are allowed to vary premiums according to subscriber characteristics. State reforms that tightened these rules provide good case studies for understanding the relationship between pricing and risk selection.

The Effect of Premiums on Consumer Health Plan Choices

Two notable experiments in "managed competition" took place in the mid-1990s: the University of California (UC) and Harvard University both offered a menu of plans that varied in generosity, but adopted a "fixed dollar contribution" policy. The plans also varied significantly in cost, so employees had a greater incentive to consider price when selecting a health plan. Because out-of-pocket premiums increased for some employees but not for others, these changes provide a natural experiment for estimating the impact of price on employee health insurance decisions. Studies that I have conducted with colleagues at the University of California, Irvine, (1) and by David M. Cutler and Sarah J. Reber, (2) analyze the effect of these policy changes on employee plan choices, total spending, and risk selection.

The results for UC and Harvard are strikingly similar. In both cases, employees were quite sensitive to price, and were willing to switch plans to save as little as $5 per month in out-of-pocket premiums. Cutler and Reber estimate a short-run premium elasticity of-2. In addition to this demand response, participating insurers lowered their premiums in order to compete for enrollment. At Harvard, the combined effect of employees shifting to lower cost plans and the premium reductions was a 10 percent reduction in total spending in one year. Over a three-year period, total spending in the UC program fell by over 25 percent. This was at a time when increased competition among managed care health plans was causing premiums to decline throughout the country, so these savings cannot be attributed entirely to the adoption of a...