Unhealthy Insurance Markets: Search Frictions and the Cost and Quality of Health Insurance by

In the United States, health insurance for those under age 65 is typically provided through group plans purchased by employers from commercial insurers. In the health insurance market, insurers provide complex multi-attribute services, and search frictions arise as employers undertake the costly process of finding appropriate health insurance for their workers. These frictions distort market outcomes by increasing insurance turnover rates, increasing the price of health insurance. Our empirical analysis indicates that frictions are most severe in the “fully insured” part of the health insurance market and that the magnitudes of the frictions in that market are sufficient to transfer a quarter of the consumer surplus from policy-holders to insurers (a transfer of 32.5 billion dollars in 1997). The capture of consumer surplus and high rates of turnover have the effect of reducing incentives to invest in the future health of policy holders.