How auto-renewal can harm competition

The following originally appeared on The Upshot (copyright 2014, The New York Times Company).

My colleagues Margot Sanger-Katz and Amanda Cox wrote recently that shopping around for the best price can be crucial for people renewing their coverage on the health insurance exchanges this fall. But evidence suggests that many people probably won’t do that. Not only is that bad for them, but it can also harm competition, which is bad for everyone.

A basic truth about health insurance, as with many other things, is that people hate to shop around and change products. They have a status quo bias. That bias can be exacerbated by a large number of plan choices, as consumers in some exchanges face.

Michael McWilliams and colleagues at Harvardfound evidence of this bias in Medicare Advantage — private plans that serve as alternatives to traditional Medicare. They found that enrollment in the program rose rapidly as the number of plans offered grew from zero to 15, but then leveled off, and declined when more than 30 plans were in the market. Too much choice can overwhelm: As the number of plans climbed above 30, Medicare beneficiaries increasingly eschewed the Medicare Advantage market completely, instead defaulting into traditional Medicare, the status quo.

Similarly, overwhelmed with increasing choice in the new exchanges, returning consumers may not relish the idea of selecting a new plan. A feature built into the exchanges practically invites them not to do so: auto-renewal. Consumers insured by an exchange plan this year who do not actively choose a new one for next year will be automatically re-enrolled in their current plan or automatically enrolled in a similar one if their plan is discontinued. This auto-renewal is meant to help increase and maintain the size of the insured population and to promote continuous coverage. But if people rely on auto-renewal without evaluating all available options, some may end up in plans that aren’t ideal for them.

Auto-renewal also offers insurers a way to retain customers without vigorously competing for them, counting on the fact that some consumers will stick with their plans even when, rationally, they should not.

Next year, the premiums of the currently cheapest silver-rated plans are going up by an average of 8.4 percent. Because of that, many of those plans will no longer be the cheapest. The customers who switch to the silver plans that are the cheapest in 2015 will see their premiums rise by only 1 percent on average. So in raising their rates by that much, those plans may be assuming that status quo bias will keep many of their enrollees from switching to new, cheaper plans offered by competitors.

There’s a paradox. Basic economic theory suggests that more choice should always improve consumers’ experience, allowing them to get better deals for less money. As choices, variety and competition increase, prices should come down, and consumers should be better able to match their preferences with product features. This theory holds up in many studies of a variety of products, but not all of them.

In this market, there are many different product features and a lot of variation in them. A recent analysis by the Robert Wood Johnson Foundation found that among silver-rated plans, primary care co-payments ranged from zero to $75, while specialist doctor co-payments varied from $10 to $150. Premiums and the networks of doctors and hospitals in each plan vary as well, as documented in a recent report by McKinsey & Company.

Variety in these dimensions and others offer consumers a lot of choice. But this variety can also challenge consumers’ ability to make comparisons, leading them to make poorer choices than they could.

Here, basic economic theory is in conflict with the finding from behavioral economics that when choices become too numerous and complex,consumers resort to heuristics (or shortcuts), leading to suboptimal decisions. For instance, when we can’t fully evaluate all options, we tend to default to familiar brands. And, because it takes time and effort to re-evaluate options, we tend to stick with our initial choice of brand when making a new purchase. This is why, for example, many people stick with their parents’ brand of car or the cellphone preferred by their friends, rather than re-evaluate all makes and models with each purchase.

A recent study by Charlene Wong and colleagues at the University of Pennsylvania sheds light on just how complex shopping for coverage can be. They closely watched and interviewed 33 young and educated adults as they attempted to navigate, the federal exchange that serves as the online marketplace for 36 states. They found that the young adults poorly understood features of insurance plans, had trouble matching plans with their preferences, and were overwhelmed and confused by the volume and types of information provided. A study by the Commonwealth Fund found that nearly one-third of users found it “very difficult or impossible” to compare benefits and out-of-pocket costs across plans.

Auto-renewal is one solution to this problem. Otherwise, if choice is too hard, some may opt out of the market, as happened with Medicare Advantage. These are people who want coverage, but not enough to do the hard work of selecting the right plan. Auto-renewal means they don’t have to do this work each year, but at the risk of getting a worse deal than they otherwise might.

If we want more competition, we need to induce fewer people to default to auto-renewal. Making it simpler for consumers to compare plans would help. Experts are already suggesting changes that could help consumers navigate insurance markets in 2015. For example, Ms. Wong and colleaguessuggest providing more accessible explanations of health plan terms, making it easier to sort plans by various features, among other ideas.

Auto-renewal exists for a reason, but if consumers rely on it too much, the results will include higher premiums and greater market power for insurers.


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