If you work for a small business and have health insurance through your company, chances are both you and your employers are overpaying for health coverage.

That's the conclusions of a researchers James Rebitzer of Boston University School of Management, and Mark Votruba and Randall Cebul, both at Case Western Reserve University’s Weatherhead School of Management, and Lowell Taylor of Carnegie Mellon University.

In a paper published in American Economic Review, they highlight the difficulties small employers have in searching for health insurance. Those difficulties, they contend, increase average health insurance premiums paid by small businesses by 29 percent. Naturally, where employees pay a portion of their health benefits, their premiums are also higher.

High plan turnover

When the four researchers began taking insurance markets’ vital signs a few years ago, one fact particularly captured their attention: small employer groups changed plans very frequently. This turnover was something of a puzzle.

“If markets are competitive, plans of similar value should be offered at similar prices,” said Votruba. “It’s costly to switch plans, so if employers are switching plans all the time, it suggests that something is impeding competition.”

The problem, they concluded, stemmed from an inability to easily comparison shop the different plans, a phenomenon economists refer to as “search frictions.”

Search frictions arise whenever consumers are unable to easily compare all the options available to them in the marketplace. This, Votruba, Cebul, Rebitzer and Taylor argue, is exactly the case for purchasers of individual and small group health plans.

Confusing options

"Consumers have hundreds, sometimes thousands, of different options, and each plan has its own unique set of benefit details,” Votruba said. “In this complex environment, it’s hard for consumers to find the plan that offers them the best value. What our paper shows is that this 'shopping problem' has important implications for how market competition plays out. If consumers have a hard time evaluating value, competition becomes less about value, and more about marketing."

Part of the problem stems from the fact there are very few sources of objective information and analysis of various health plans. Most experts who can provide this information are usually trying to sell their own plan.

No need for competition

How this works against consumers, the researchers say, is that all the companies selling health insurance can be less competitive and charge higher rates. Instead of competition forcing all insurers to offer similar plans at a similar low price, frictions enable many insurers to profitably pursue high margin/low volume strategies.

The net effect is that consumers end up paying more for their health insurance – 29 percent more on average in the small group market – and insurers spend more on marketing.

Because it's hard to find objective information about plans, employers are never quite sure they are getting the best deal. That can lead to frequent changes, as businesses drop one plan and go with another.

"High turnover rates undermine the quality of health plans by reducing insurers’ incentive to finance care that makes their policyholders healthier in the future," Cebul said. "Why spend money on wellness or disease management programs – programs which yield a return on investment only after several years – for a policyholder who probably isn’t going to stick around long?"

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