The Science of Why Good People Choose Bad Health Plans

Don’t look now, but it’s almost that time again.

No, not Halloween, and not the World Series. It is just a few weeks until open enrollment, your annual month-long chance to change health insurance plans, potentially saving serious money in the process.

That sounds good, but many people ignore the opportunity and opt to stick with the plan they have. That inertia can be expensive. In one study, employees in health plans that were not optimal for them wound up overpaying for health care to the tune of 42% of their annual premiums.

There are a number of reasons why we ignore this task or perform it poorly. Some are just part of our mental wiring—but if you are aware of them, you may be able to push through and find a better, less costly option.

Choice Overload

Having wide array of plans should make it easier to choose what’s right for you. But in reality, that’s not what happens, at least for some people. Experts have found that beyond a certain point, too many choices can actually reduce the chances that people will make optimal decisions.

For example, in a study of how people select 401(k) plans from a menu of choices, Sheena Iyengar, a professor at Columbia University, found that subjects’ willingness to enroll in a plan could diminish when they were offered more choices. (Then, when they did enroll, they were also more likely to invest in simple but low-yielding assets like bonds and money market funds.)

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Health insurance can be yet more complicated than 401(k)s. And even when employers are not offering a wide array of plans, overload can still kick in. For example, if an employer offers only three health plans but each has four possible levels of deductibles, that constitutes 12 options. If employees also have two choices for maximum copayments and two for maximum out-of-pocket spending, that equates to 48 options to consider.

Loss Aversion

When you choose a health plan, you gain something—protection from a potential catastrophic expense—and you lose something via the premiums and deductible you pay. Logic would suggest that people could find a balance between the two.

In reality, though, we are wired to be more averse to losses than enthusiastic about gains. Daniel Kahneman, an emeritus professor of psychology and public affairs at Princeton, has demonstrated this with students. When he offered a coin toss and told them that they would lose $10 if it came up tails, they would only participate if they had the chance to win at least $20 from the other outcome.

How does this relate to health insurance? It colors how much “risk” people are willing to take on. A slightly higher deductible may seem more undesirable than it actually is because even if it comes with a much lower premium, it locks a person into a definite “loss.”

Two economists from Carnegie Mellon recently studied what happened when employees of a large corporation were choosing among 48 different health insurance options. Some offered slightly higher deductibles but significantly lower premiums and were clearly better deals. But even so, 61% of the employees chose suboptimal plans.

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Saurabh Bhargava, an assistant professor of economics at Carnegie Mellon and one of the study’s authors, said that not even he could convince his own mother to switch to a higher deductible plan that would have cost her less, despite hours of trying.

“My mom hated the idea of a high deductible not because she couldn't afford it,” he said. “She hated the idea of being in a situation where she has to judge whether this particular pain is worth the trip to the emergency room or the $100 copay.”

Blissful Ignorance

Choice overload and loss aversion can certainly color your thinking about health insurance, but Bhargava has identified what he considers a bigger factor: widespread lack of understanding of how health insurance works.

He and his colleague, George Lowenstein, asked study subjects to choose from four health insurance plans that only varied by price and deductible. Even with that simplified choice, half of the subjects chose plans that would cost them more.

“Is it a matter of educating people in school or through firms or do we need to do something else?” Bhargava said. As it stands now, “people are made worse off due to the complexity, and there is disproportionate impact on the poor and less educated.”

How to Push Through and Choose a Plan

Getting over these hurdles is tricky, but it can be done. Before confronting an array of choices, step back and identify your objective: is it maximizing cash flow, avoiding the risk of a sudden expense, staying with your existing doctors, or something else?

To overcome loss aversion, try some simple math. Like Bhargava's mother, you may think you want a low deductible for peace of mind. But if you calculate what that deductible actually costs you—for example, does your employer contribute to a health savings account to help offset the cost of a high-deductible plan?—you may arrive at a different conclusion. Money’s guide to open enrollment can help you make the right choices.

Bhargava has another suggestion for easing the process. Perhaps, he said, “insurance just needs to be made simpler.”