Product Design and Consumer Choices in the Individual Insurance Market

What is the cost of the last article of clothing you bought. This is easy to determine, just check your credit card statement.

Which is cost of health insurance? This answer is more difficult to find. Sure, there is the price of the premium, but different insurance plans have different co-pay/co-insurance levels and different deductible amounts. How do these insurance product design parameters affect the demand for insurance?

This is the question tackled by Marquis et al. (2007). The authors use a nested logit model to examine plan characteristics within the individual insurance market. In their nested logit, the authors assume individuals first choose whether to be insured or not. Then, they must choose which type of insurance (PPO, POS, HMO, etc.). After they choose which type of plan they prefer, then a carrier is chosen. This methodology is based on the work of McFadden (1978).

The authors find an elasticity estimate of -2.0 for plan choice among purchaser. This means that those who are insurer are very price sensitive. However, Marquis and co-authors also find that once a particular company is selected, there are significant switching costs to changing companies. The elasticity of switching companies once a plan type (PPO, HMO etc.) is chosen is only -0.4.

The authors also find that:

…a 3 percent decrease in the actuarially adjusted price (or a 4 percent decrease in the nominal premium) would induce a healthy consumer to switch to a plan with a 50 percent higher deductible. For a riskier consumer, however, it would take a 4.5 percent decrease in the actuarially adjusted premium (or a 5.5 percent decrease in the nominal premium) to make the switch. This suggests that there is potential for selection in consumer-directed health plans—an outcome that concerns many critics of these new plans. In addition, the findings suggest that introducing new high-deductible products is unlikely to play a major role in reducing the number of uninsured.

Consumer education regarding the choice of different plans and help to expand coverage by introducing consumers to low-cost (actuarially) insurance options.

• Marquis MS, Buntin MB, Escarce JJ, Kapur K. (2007). “The Role of Product Design in Consumers’ Choices in the Individual Insurance Market” HSR 42(6) : 2194-2223.
• McFadden, D. 1978. “Modelling the Choice of Residential Location.” In Spatial Interaction Theory and Residential Location, edited by A. Karlquist, pp. 75–96.
  
  Amsterdam: North-Holland.