Academic journal article Economic Inquiry

Efficiency in Employment-Based Health Insurance: The Potential for Supra-Marginal Cost Pricing

Academic journal article Economic Inquiry

Efficiency in Employment-Based Health Insurance: The Potential for Supra-Marginal Cost Pricing

Article excerpt

I. INTRODUCTION

This paper explores several theoretical models of employment-based health insurance which indicate that price may be set above marginal costs even when the market for insurance appears competitive by traditional measures (such as concentration ratios and entry/exit rates). A great deal of attention has been paid in recent years to health insurance and its role in the escalating resource drain that the health services sector places on the U.S. economy. Concerns over rapidly increasing prices, the lack of access to health care experienced by millions of Americans and other issues have prompted increasingly urgent calls for reform.

One of the few industries in the health services sector that is perceived as reasonably competitive is the private health insurance industry. The Clinton Administration's health care reforms relied heavily upon mandated employment-based health insurance to assure universal coverage. This plan, if re-introduced during the next Congress, would require all firms to provide private health insurance to their employees. This paper argues that this point warrants further consideration; our current understanding of competition in the insurance market does not recognize the severe barriers that exist between actual buyers and sellers of employment-based health insurance. Several theoretical models presented below will demonstrate that since an employee is not generally free to purchase insurance from any insurer, common indicators of competition are of little value.

Much of the previous research into the level of competition in the health insurance (henceforth "insurance") industry has utilized traditional measures of competition, familiar to any student of industrial organization. For example, historically the number of firms selling insurance in an area is seen as positively related to the level of competition. Frech and Ginsburg [1978], and their follow-up study, Frech and Ginsburg [1988], are two widely cited, and typical, investigations. They present a high rate of entry and exit and very low levels of concentration as evidence that the market for private insurance is reasonably competitive, despite the large market shares of the Blue Cross/Blue Shield plans. A more recent review by Frech [1993] reiterates this position, noting that no private insurer has a market share in excess of 1 or 2 percent.(1) This work presumes that the large number of insurers in an area actually compete, in the sense that they share a common customer pool at all times. This assumption is disputed in greater detail below.

Several researchers have noted the limited options which most consumers of health insurance face; however, their primary interest has been in explaining how agents make such constrained choice. Ellis [1989] examines the choices made by employees for health insurance coverage when they are presented with a limited set of complex alternatives. He finds that agents are sensitive to such factors as premiums and deductibles, but often behave in ways that appear to be less than fully informed. Feldman et al. [1989] is another paper that analyses how employers decide upon which health insurance plan to purchase. They also find sensitivity to premiums, deductibles and other non-monetary factors (such as age). Enthoven [1990] argues that the kinds of choices analyzed by Ellis and Feldman et al. do not represent competition since employees are often sheltered from price by their employers. He notes that when employers contribute toward the purchase of insurance in a way that reduces the employees' sensitivity to price (for example by paying the entire premium or some fixed percent of the premium for the employee) competition is severely hampered.(2) While these researchers have recognized the limitations placed on employee choice with respect to the purchase of health insurance, they have not attempted to evaluate the impact of such constraints on the potential for competition in the insurance market. …

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