The Impact of Consumer Inattention on Insurer Pricing in the Medicare Part D Program∗

Medicare Part D presents a novel privatized structure for a government pharmaceutical benefit. Incentives for firms to provide low prices and high quality are generated by consumers who choose among multiple insurance plans in each market. To date the literature has primarily focused on consumers, and has calculated how much could be saved if they chose better plans. In this paper we take the next analytical step and consider how plans will adjust prices as consumer search behavior improves. We use detailed data on enrollees in New Jersey to demonstrate that consumers switch plans infrequently and imperfectly. We estimate a model of consumer plan choice with inattentive consumers. We then turn to the supply side and examine insurer responses to this behavior. We show that high premiums are consistent with insurers profiting from consumer inertia. We use the demand model and a model of firm pricing to calculate how much lower Part D program costs would be if consumer inattention were removed and plans re-priced in response. Our estimates indicate that consumers would save $601 each over three years when firms’ choice of markup is taken into account. Cost growth would also fall: by the last year of our sample government savings would amount to $224 million per year or 4.1% of the cost of subsidizing the relevant enrollees. ∗We thank Mark Duggan, Liran Einav, Gautam Gowrisankaran, Ben Handel, Robin Lee, Bentley MacLeod, Eric Johnson and participants at the NBER I.O. Summer Institute for helpful comments. We especially thank Francesco Decarolis for sharing his data with us. All errors are our own. †Columbia University and NBER, [email protected]. ‡Columbia University, [email protected]. §Yale University and NBER, [email protected].