How Product Standardization Affects Choice: Evidence from the Massachusetts Health Insurance Exchange (NBER Working Paper 19527, joint with Amanda Starc).
Standardization of complex products is touted as improving consumer decisions and intensifying price competition, but evidence on standardization is limited. We examine a natural experiment: the standardization of health insurance plans on the Massachusetts Health Insurance Exchange. Pre-standardization, firms had wide latitude to design plans. A regulatory change then required firms to standardize the cost-sharing parameters of plans and offer seven defined options; plans remained differentiated on network, brand, and price. Standardization led consumers on the HIX to choose more generous health insurance plans and led to substantial shifts in brands’ market shares.
The Size of the LGBT Population and the Magnitude of Anti-Gay Sentiment are Substantially Underestimated (NBER Working Paper 19508, joint with Katherine B. Coffman and Lucas C. Coffman).
Measuring sexual orientation, behavior, and related opinions is difficult because responses are biased towards socially acceptable answers. We test whether measurements are biased even when responses are private and anonymous and use our results to identify sexuality-related norms and how they vary. We run an experiment on 2,516 U.S. participants. Participants were randomly assigned to either a “best practices method” that was computer-based and provides privacy and anonymity, or to a “veiled elicitation method” that further conceals individual responses. Answers in the veiled method preclude inference about any particular individual, but can be used to accurately estimate statistics about the population. Comparing the two methods shows sexuality-related questions receive biased responses even under current best practices, and, for many questions, the bias is substantial. The veiled method increased self-reports of non-heterosexual identity by 65% (p<0.05) and same-sex sexual experiences by 59% (p<0.01). The veiled method also increased the rates of anti-gay sentiment. Respondents were 67% more likely to express disapproval of an openly gay manager at work (p<0.01) and 71% more likely to say it is okay to discriminate against lesbian, gay, or bisexual individuals (p<0.01). The results show non-heterosexuality and anti-gay sentiment are substantially underestimated in existing surveys, and the privacy afforded by current best practices is not always sufficient to eliminate bias. Finally, our results identify two social norms: it is perceived as socially undesirable both to be open about being gay, and to be unaccepting of gay individuals.
The Endowment Effect (NBER Working Paper 19384, joint with Andreas Fuster).
The endowment effect is among the best known findings in behavioral economics, and has been used as evidence for theories of reference-dependent preferences and loss aversion. However, a recent literature has questioned the robustness of the effect in the laboratory, as well as its relevance in the field. In this review, we provide a summary of the evidence, and describe recent theoretical developments that can potentially reconcile the different findings, with a focus on expectation-based reference points. We also survey recent work from psychology that provides either alternatives to or refinements of the usual loss aversion explanation. We argue that loss aversion is still the leading paradigm for understanding the endowment effect, but that given the rich psychology behind the effect, a version of the theory that encompasses multiple reference points may be required.
The Articulation Effect of Government Policy: Health Insurance Mandates Versus Taxes (NBER Working Paper 18913, joint with Judd Kessler).
We examine how the articulation of government policy affects behavior. Our experiment compares a government mandate to purchase health insurance to a financially equivalent tax on the uninsured. Participants report their probability of purchasing health insurance under one of the two articulations of the policy. The experiment was conducted in four waves, from December 2011 to November 2012. We document the controversy over the Affordable Care Act’s insurance mandate provision that changed the political discourse during the year. Pre-controversy, articulating the policy as a mandate, rather than a financially equivalent tax, increased probability of insurance purchase by 10.6 percentage points — an effect comparable to a $1000 decrease in annual premiums. After the controversy, the mandate is no more effective than the tax. Our results show that how a policy is articulated affects behavior and that persuasion and public opinion management can help achieve policy objectives at lower cost.
Pricing Regulation and Imperfect Competition on the Massachusetts Health Insurance Exchange (NBER Working Paper 18089, joint with Amanda Starc).
We analyze consumer demand and model the effect of pricing regulation under imperfect competition using data from the Massachusetts health insurance exchange. We identify consumer demand using coarse insurer pricing strategies. There is substantial heterogeneity in preferences by consumer type, with younger consumers twice as price sensitive as older consumers. As a result, older consumers face higher markups over costs. Modified community rating links prices for consumers that differ in both costs and preferences. Constrained prices are not simply the population-weighted average of unconstrained prices, because community rating changes the marginal consumer firms face. Tightening rating regulations transfers resources from low cost to high cost consumers, but also reduces firm profits and increases overall consumer surplus. We use our model to examine other insurance regulations. For instance, minimum loss ratios (designed to limit firm profits) will also alter the transfers between consumers. Moreover, risk adjustment will be insufficient to equalize prices across consumer types, as markups still differ. As a result, without a mandate, the market can unravel due to differences in preferences alone.
Published and Forthcoming Papers
Consumer Inertia and Firm Pricing in the Medicare Part D Prescription Drug Insurance Exchange. AEJ: Economic Policy, Forthcoming
I use the Medicare Part D prescription drug insurance market to examine the dynamics of firm interaction with consumers on an insurance exchange. Enrollment data show that consumers face switching frictions leading to inertia in plan choice, and a regression discontinuity design indicates initial defaults have persistent effects. In the absence of commitment to future prices, theory predicts firms respond to inertia by raising prices on existing enrollees, while introducing cheaper alternative plans. The complete set of enrollment and price data from 2006 through 2010 confirms this prediction: older plans have approximately 10% higher premiums than comparable new plans.
The Massachusetts health care reform provides preliminary evidence on the function of health insurance exchanges and individual insurance markets. We describe the type of products consumers choose and the dynamics of consumer choice. Evidence shows that choice architecture affects choice, including product standardization and the use of heuristics (rules of thumb). In addition, while consumers often choose less generous plans in the exchange than in traditional employer-sponsored insurance, there is considerable heterogeneity in consumer demand, as well as some evidence of adverse selection. We examine the role of imperfect competition between insurers, and document the impact of pricing and product regulation on the level and distribution of premiums. Given our extensive choice data, we synthesize the evidence on the Massachusetts exchange to inform the design and regulation on other exchanges.
We examine heuristic decision rules in consumer choice on health insurance exchanges using data from the Massachusetts Connector. Consumers may have difficulty making optimal choices in a complex environment. The heuristic “choose the cheapest plan” is suggested by the decision context, previous research, and the data: about 20% of enrollees choose the cheapest plan possible. We find evidence of this heuristic in many models, but while heuristics may play a role, preference heterogeneity is also important. Our most flexible models find an insignificant heuristic effect, in part because, holding context fixed, this heuristic is observationally equivalent to extreme price sensitivity.
Substantial evidence suggests that people are loss averse: they weigh losses more heavily than equivalent gains. Yet little is known about the reference point relative to which gains or losses are defined. The most common assumption is that the reference point is given by a person’s current endowment (the status quo). We conduct two experiments that instead provide evidence that a person’s expectations about outcomes determine her reference points. In the first experiment, we endow subjects with an item and randomize the probability they will be allowed to trade it for an alternative. Subjects that have a lower exogenous probability of being able to trade their item (and who therefore expect to keep it) are less likely to choose to trade when such an opportunity arises. This is predicted when reference points are expectation-based, but not when they are determined by the status quo. Our second experiment provides a quantitative measure of the effect of expectations on subjects’ monetary valuation of an item. We randomly assign subjects a high (80%) or low (10%) probability of obtaining an item for free, and then elicit their willingness-to-accept for the item conditional on receiving it. Being in the high probability treatment increases valuation of the item by 20-30%. These results shed light on the circumstances under which loss aversion will affect individual behavior and market outcomes, and reconcile conflicting findings regarding the existence of endowment effects in different settings.
Do individuals have unbiased beliefs, or are they over- or underconfident? This paper documents overconfidence in a domain relevant for many economic decisions: prospective memory (memory for action). I use an incentivized experimental design that is more robust to potential confounds than previous research. Subjects chose between smaller automatic payments and larger payments they had to remember to claim at a six-month delay. In a large sample of college and MBA students at two different universities, subjects make choices that imply a forecast of a 76% claim rate, but only 53% of subjects actually claimed the payment.
We consider how to conduct cost-effectiveness analysis when the social cost of a resource differs from the posted price. From the social perspective, the true cost of a medical intervention is the marginal cost of delivering another unit of a treatment, plus the social cost (deadweight loss) of raising the revenue to fund the treatment. We focus on pharmaceutical prices, which have high markups over marginal cost due to the monopoly power granted to pharmaceutical companies when drugs are under patent. We find that the social cost of a branded drug is approximately one-half the market price when the treatment is paid for by a public insurance plan and one-third the market price for mandated coverage by private insurance. We illustrate the importance of correctly accounting for social costs using two examples: coverage for statin drugs and approval for a drug to treat kidney cancer (sorafenib). In each case, we show that the correct social perspective for cost-effectiveness analysis would be more lenient than researcher recommendations. Request a copy via email
Time discounting for primary rewards, by McClure, S., Ericson, K., Laibson, D., Loewenstein, G., and Cohen, J., Journal of Neuroscience 27:5796-804. 2007.
Previous research involving monetary rewards found that limbic reward-related areas show greater activity when an intertemporal choice includes an immediate reward than when the options include only delayed rewards. In contrast, the lateral prefrontal and parietal cortex (areas commonly associated with deliberative cognitive processes, including future planning) respond to intertemporal choices in general but do not exhibit sensitivity to immediacy. This paper extends these findings to primary rewards (fruit juice or water) and time delays of minutes instead of weeks. Thirsty subjects choose between small volumes of drinks delivered at precise times during the experiment (e.g., 2 ml now vs 3 ml in 5 min). Limbic activation was greater for choices between an immediate reward and a delayed reward than for choices between two delayed rewards. In contrast, the lateral prefrontal cortex and posterior parietal cortex responded similarly whether choices were between an immediate and a delayed reward or between two delayed rewards. Relative activation of the two sets of brain regions predicts actual choice behavior
Other Working Papers
Defaults do not merely affect individual behavior, they also have equilibrium effects on firm pricing. Dynamic defaults for recurring purchases apply in many markets and determine what happens to individuals already enrolled in a product or service if they take no action at a decision point. Consumers may face automatic renewal, automatic switching, or non-purchase defaults. The privately optimal dynamic default depends on the relative contributions of psychological inactivity factors and real switching costs to individual inertia. The socially optimal default also depends on the response of firms, as nonrenewal defaults can raise the elasticity of repeat demand, restrain firms’ price increases on inertial customers, and ultimately reduce inefficient switching.
Sophistication and Insurance: Asymmetric Information, the Ability to Game the System, and Prescription Drug Insurance.
In complex insurance contracts, individuals can use sophisticated strategies to avoid out-of-pocket expenses. Sophistication and expected claims are affected by similar factors, creating a systematic positive or negative correlation between them. Depending on this correlation, sophistication can lead to advantageous or adverse selection, and selection may differ between the intensive and extensive margin. Responding to sophistication, insurers may distort contracts by making them excessively simple or complex, to reduce or magnify enrollees’ ability to game the system. I show two sophisticated prescription drug-related behaviors each reduce out-of-pocket prescription drug costs by half and are strongly associated with expected claims.Research Papers