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CHAPTER 2. HEALTH PLAN CHOICE 98
effects, due to very low demand elasticity. 23 Note that these papers all focus on
uniform pricing, which we have noted is generally inefficient except in special cases.
When we use our estimates to compare observed pricing to optimal uniform prices,
we find welfare costs of approximately 1-3% of coverage costs. In this sense, there
appears to be a fair amount of agreement between studies.
As a group, these studies also reinforce our earlier observation that inefficiencies
from pricing can be driven both by the nature of sorting and risk-selection, and by the
price elasticity of demand, which determines the extent to which implicit subsidies or
taxes affect choices. To guage the sensitivity of our own estimates to these factors,
we recalculated the surplus difference between the observed and the feasible efficient
allocation assuming that demand was twice as sensitive to price as we have estimated,
and half as sensitive. We performed a similar analysis varying the risk sensitivity of
demand. These analyses increase the range of the welfare gains to 1-13% of total
coverage costs. Given the range of demand estimates in the literature, one may want
to assign a corresponding range of uncertainty to the potential welfare costs of price
distortions.
2.6 Conclusion
Economists have long understood that competition in health insurance markets is no
guarantee of efficiency. This paper contributes to a nascent literature that attempts
to quantify market inefficiencies and identify their sources. A main finding is that
observed contribution policies distort enrollment decisions from their efficient level.
We calculate that the welfare loss is on the order of 2-11% of the total cost of coverage.
Capturing these gains in full would require the use of risk-rated contribution policies.
Absent such policies, optimally set employee contributions might increase welfare by
1-3% of coverage costs. A key point to emphasize is that despite these distortions,
there appear to be substantial gains in our context from introducing plan choice at
23 One explanation for their inelastic demand estimate is that they rely on time-series variation
in contributions. As discussed above, employees appear to be more price sensitive in making initial
choices than in making changes once they are enrolled.