Khan: Infinite choices not necessary for true freedom of choice in health care exchange

Guest blogger Zarak Khan is writing a series of pieces for the Pulse about issues surround the new marketplace for health care under Obamacare.  After NC’s decision not to set up its own marketplace and reject federal money available for Medicaid, the marketplace or health exchange in NC will be run by the federal government.  People who don’t get health insurance through their work can get tax credits to buy affordable private health plans in the marketplace.  There are pretty important issues as to how this marketplace gets set up however.  The one Khan tackles this week is counterintuitive:  What the adverse effect might be of  having a choice of too many health plans in NC’s marketplace.

The idea of the free market is a powerful and guiding force in the US economy.  In theory a perfectly free market is one without restrictions or government interventions in the form of regulations, taxes, subsidies and other mechanisms generally thought to distort the market (i.e. make some goods cheaper or more expensive than they would otherwise be).

There are, however, several things that must be in place for a free market to exist and function fairly. Among them are:

• Perfect competition–the market cannot be controlled by a monopoly or cartel. There is a low cost to enter a market and transaction costs are low.
• Perfect information–consumers need to have complete understanding of what it is that they are buying.
• No externalities–there can’t be some additional cost or benefit that is not included in the transaction. Pollution is the most common example–without regulation, it would not be included in the price of producing a good.
• Public goods–some things, such as national defense, are common to everyone in the community and you would not want to move it into the private market.
• Perfectly rational consumers–people understand the decision and process information in a way that maximizes the benefit to themselves.

When one of these is off-kilter, the government will sometimes intervene in an attempt to correct the market and make it more efficient. This might come in the form of a tax or subsidy or in a new regulation. This is why we don’t consider the US economy to be a perfectly free market, but rather a ‘regulated free market’.

Several of the above conditions do not hold in our health insurance market. When it comes to behavioral economics, the focus is primarily on people as rational actors. Do people always make the best choices? Do they put aside biases and emotions when making a decision? Do people have complete understanding of all the repercussions of their actions? A quick review of our own behavior and the actions we observe on a daily basis reveals that the answer is clearly ‘no’.

In many cases, we rely on experts to make decisions for us. For example, I don’t go to the hospital and tell the doctor what treatment I need. I defer to her expertise and training to guide me to a good decision. We often rely on our friends and family for guidance when making everyday decisions (‘Is this a good car?” “Should I buy these tools?”). Whoever it is, we defer to the experts in our lives every day.

This brings up the question: does offering a limited number of choices hinder the free market? The right answer, as is often the case with difficult topics, is maybe. Behavioral research has demonstrated that some limits on the number of choices a person must make can lead them to a better decision (and one they feel better about).  At the same time, if the limits were so prohibitive that they essentially led to a monopoly, then they would be a hindrance to efficiency. The key is finding the sweet spot of enough choice without overwhelming the consumer. This is why health insurance exchanges under the new health care law must be responsible curators of insurance plans in their states.

A health insurance marketplace with literally thousands of different plans – essentially what we have now – offers little but confusion.  For example, most small business owners want to spend their time growing their businesses and serving customers, not sorting through thousands of complex health plans.  A health marketplace that offers a reasonable number of plans from high-deductible catastrophic coverage to more comprehensive health insurance is easier to sort through and make a choice that is in line with what an individual or business really needs.