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CHAPTER 2. HEALTH PLAN CHOICE 77
2.4 Econometric Model
2.4.1 Consumer Preferences, Plan Costs and Market Behav-
ior
In this section, we develop an econometric model that allows us to jointly estimate
consumer preferences and health plan costs. It should be noted that by costs we mean
overall costs to the insurer for a given enrollee in a given plan. Although we discuss
factors that may explain the variation in costs below, overall cost is sufficient for
welfare analysis and it is not necessary to decompose whether these cost differences
arise from, for example, moral hazard or physician reimbursement rates or some other
factor (c.f., ?).
In contrast to the simple theoretical model discussed above, the econometric model
allows for multiple plans, varying plan characteristics, and both observable and pri-
vately known dimensions of health risk and consumer tastes. Nevertheless, we aim
for the most parsimonious model that permits a credible assessment of market ef-
ficiency. In what follows, we describe the key components of the model: consumer
choice, health plan costs, health plan bidding, and employer contribution setting, and
identify the stochastic assumptions on the unobservables that permit estimation.
Consumer Choice
We use a standard latent utility model to describe household choice behavior,
where a household’s (money-metric) utility from choosing a plan depends on a com-
bination of household and plan characteristics. Specifically, household h’s utility from
choosing plan j is:
uhj = φjαφ + xhαxj + ψ(rh + µh; αrj) − pj + σεεhj. (2.1)
In this representation, household utility depends on observable plan characteris-
tics φj, the monthly plan contribution pj, 12 observable household demographics xh,
12 We convert employee contributions, which are made with pre-tax dollars, to post-tax dollars by
adjusting them by the marginal tax rate (see Footnote 13 for discussion). For a given household