(Bloomberg) -- A few days back, David Goldhill, whose writing about health care I have long admired, wrote
Goldhill’s argument is complicated. Here’s the gist: First, the subsidies are determined by the price of the second cheapest silver plan on the exchange. The system calculates what percentage of your income you’re supposed to pay -- for a family of four making $32,500, that amount is 3.29 percent of income, or a little more than $1,000 a year. The system looks at the second cheapest silver plan, and subtracts the amount that you’re supposed to pay. What’s left is your subsidy. If you buy a cheaper “bronze” plan, you can pay little or nothing, with the subsidy covering the whole thing. If you buy a more expensive plan, you have to make up the difference.
Goldhill’s contention is that insurers will basically converge around one (high) price for silver plans, which will maximize the subsidies they get. Transparency is supposed to improve markets, but Goldhill is arguing that it will actually undermine the market for insurance.
Is this possible? Well, there’s one intriguing experiment that suggests it is. In “More Information, More Ripoffs: Experiments with Public and Private Information in Markets with Asymmetric Information” (Review of Industrial Organization; Vol. 36 No. 1, 2010), Bart J. Wilson and Arthur Zillante tried to replicate George A. Akerlof’s famous “lemons” problem, where asymmetrical information between buyers and sellers causes sellers to pass off inferior goods, and undermines the market until only shoddy products are being offered (such as the market for used cars). They couldn’t replicate it -- until they posted the prices publicly. Here’s Wilson describing the experiment to me in an e-mail:
Sellers know if they are hocking regulars or supers, but the buyers won't know until they have purchased the good which one they have. Supers cost more to produce, but they also have a much higher value for the buyers than regulars. If the posted prices by all of the sellers are public so that everyone, especially the sellers, can see them, then the sellers of regulars price just below the cost of the supers and sell lemons to the buyers. But if the prices are not publicly posted but buyers can visit the sellers and comparison shop on their own, the prices separate to distinguish regulars from supers and no buyer purchases a regular thinking it is a super. The results are quite stark. This isn't an iffy finding.
This seems crazy. How could transparency undermine a market? Isn’t transparency supposed to make markets better? But in the experimental market, it was the opposite: When sellers could see what the competition was doing, that increased their ability to cheat the customer.
Nor is it only in experimental markets that you see results like this. For example, witness the “AudioQuest K2 Terminated Speaker Cable -- UST 2.44 m Plugs 8' Pair” available on Amazon for $13,000. (Actual value: maybe as much as $200, according to my audiophile husband, but probably significantly less.) This sales price spawned some of the best humorous Amazon reviews ever, including this classic of the genre:
We live underground. We speak with our hands. We wear the earplugs all our lives. PLEASE! You must listen! We cannot maintain the link for long... I will type as fast as I can. DO NOT USE THE CABLES! We were fools, fools to develop such a thing! Sound was never meant to be this clear, this pure, this... accurate. For a few short days, we marveled. Then the... whispers... began. Were they Aramaic? Hyperborean? Some even more ancient tongue, first spoken by elder races under the red light of dying suns far from here? We do not know, but somehow, slowly... we began to UNDERSTAND. No, no, please! I don't want to remember! YOU WILL NOT MAKE ME REMEMBER! I saw brave men claw their own eyes out... oh, god, the screaming... the mobs of feral children feasting on corpses, the shadows MOVING, the fires burning in the air! The CHANTING! WHY CAN'T I FORGET THE WORDS??? We live underground. We speak with our hands. We wear the earplugs all our lives.
What happened? Well, many sellers in Amazon’s third-party marketplace use bots that scan the other prices for the product and set theirs to just above, or just below, the very cheapest bid. It’s one of the commonplaces of retail that people often like to buy the second or third cheapest product. Apparently, two cable resellers set their bots to price the cable just above the cheapest competitors. Unfortunately, there were only two sellers for this particular product. The result was a bidding war. When I first happened upon this listing, the price was somewhere in the low four digits.
(At this point, I assume that they’ve just left their listings up for the entertainment value.)
But does the insurance market reflect these sorts of anomalies?
Well, insurance is definitely a product where it’s hard to know the quality you’re getting in advance. Does it cover the providers and procedures you might want? How much will the company hassle you if you make a big claim? You can see a scenario where the market focuses buyer attention on the few pieces of information it provides -- price, deductible -- which encourages insurers offering a less valuable product to ratchet their prices upward to those of the higher-quality insurers.
Especially since both buyers and sellers only get one chance a year: Sellers have to set their price for the whole year in advance, and buyers can only change their insurance during the two-month open enrollment period. (Open enrollment lasts for six months this time, but going forward, it will be much shorter.) Since it’s disastrous to set your price too low, and lose money, insurers may have an incentive to raise their prices higher than normal. And on the other side, it’s hard for people to acquire information about how good an insurer is going to be, so there may be some incentive to rely on quality signals like price -- especially if you aren’t paying that price.
In smaller markets, we could also see Amazon-style anomalies; research by Bloomberg Government indicates that those places with fewer sellers have higher prices.
Interestingly, most of the benefit seems to come when you have four insurers in the market; after that, the price band gets narrower, but the median price doesn’t drop that much.
On the other hand, the more enrollees you have, the better you can spread your risks across a large pool -- you’re less likely to find your finances torpedoed by a small number of very sick people. So insurers have incentives to attract lots of customers. (That’s why they lobbied hard for the individual mandate!) That competitive pressure could be enough to keep the markets efficient.
What it really comes down to, I think, is this: What scares insurers most? If they’re most afraid of having too few customers, they’ll keep their pricing aggressive, and prices may stay low. If they’re most afraid of underpricing their services, they’ll err on the side of overcharging, and prices may converge on much higher rates for the silver plans that drive the subsidies. If that happens, the cost to the government would spiral out of control.
