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Price Elasticity of Demand in Employer-Provided Self-Insured Health Plans

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This paper studies the price elasticity of demand in the employer-provided self-insured health plans. The price of self-insurance is defined as the "loading fee" that mainly refers to the administrative costs of insurance that are recognized as its implicit price. Further, the administrative costs of self-insured health plans are expressed as a fraction of benefits claims. The performed empirical analyses estimate the price elasticity of demand for self-insured health plans to be approximately equal to -0.13 in all the models specified, except those with interaction terms. When model specifications are extended by two interaction effects, the price elasticity of demand is estimated to be approximately equal to -0.36. The measures of the price elasticity of demand for self-insured health plans accord well with estimates of other types of health insurance that found the price elasticity of health insurance to be inelastic.
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Price Elasticity of Demand in
Employer-Provided Self-Insured Health Plans


Iwona Kicinger1 and Robin Hanson2
Department of Economics
George Mason University
Fairfax, VA 22030










1 Ph.D. student, Department of Economics, 4400 University Drive, Fairfax, VA 22030,
Phone: 703-341-9869, E-mail: ikicinge@gmu.edu (Corresponding author)
2 Associate Professor of Economics, Department of Economics, MSN 1D3, Carow Hall,
Fairfax VA 22030-4444, http://hanson.gmu.edu, Phone: 703-993-2326, Fax: 703-993-
2323, E-mail: rhanson@gmu.edu

Price Elasticity of Demand in
Employer-Provided Self-Insured Health Plans


Abstract
This paper studies the price elasticity of demand in the employer-provided self-insured
health plans. The price of self-insurance is defined as the “loading fee” that mainly refers
to the administrative costs of insurance that are recognized as its implicit price. Further,
the administrative costs of self-insured health plans are expressed as a fraction of benefits
claims. The performed empirical analyses estimate the price elasticity of demand for
self-insured health plans to be approximately equal to -0.13 in all the models specified,
except those with interaction terms. When model specifications are extended by two
interaction effects, the price elasticity of demand is estimated to be approximately equal
to -0.36. The measures of the price elasticity of demand for self-insured health plans
accord well with estimates of other types of health insurance that found the price
elasticity of health insurance to be inelastic.



Keywords: price elasticity; demand; employer-provided health insurance; self-insured
health plans; labor market


1

1. Introduction
The demand for health care, its specific services and its responsiveness to price has been
long studied in the economic literature (Ringel, Hosek et al. 2002). In particular, the
issue of the price responsiveness of demand for health insurance is critical in analyzing
the effectiveness and relevance of various health insurance policies proposed over the
years (Chernew, Frick et al. 1997; Blumberg, Nichols et al. 2001). These health policy
proposals have been largely designed to decrease the growing number of uninsured
people in the US, which is estimated to include approximately over 43 million (Hoffman
and Schlobohm 2000; Rhoades, Vistnes et al. 2002). Moreover, “the degree of
responsiveness to price or insurance coverage is important because, other things equal,
services that are more elastic should be less insured” (Haas-Wilson, Cheadle et al. 1989).
Similarly, the most dominant form of providing health insurance coverage nowadays in
the US through the employment is also critically conditional on health plans’ price
sensitivity (e.g., employers relate their decisions to premium costs, as shared by
employees and employer) (Abraham, Vogt et al. 2002).

The extensive work up to date on the price elasticity of the demand for health insurance
coverage encompasses the whole variety of empirical studies that differ from each other
with respect to the data sources, methodology, as well as empirical and experimental
methods used. This further results in “no definitely established range of price elasticities
[of health plan choice] in the literature” (Royalty and Solomon 1999). However, in
general, the estimates of the price elasticity are found to be inelastic across studies with

2

their mid-estimate of -0.17 (Ringel, Hosek et al. 2002)3. On the other hand, specific
health care services are estimated to be more price sensitive relative to price estimates for
health care in general.4

This paper focuses on the price elasticity of demand in the context of self-insured/funded
health coverage within employer-sponsored health plans. Employer provided self-
insurance is defined here as health coverage where the employer does not contract with
an insurance company to assume the financial risk (as opposed to conventional/traditional
health plans), but instead it assumes internally all or part of the financial risk associated
with paying potential medical claims. Hence, it acts as its own health insurance firm,
suggesting that it pays for its employees’ medical claims out of its own pockets.

Specifically, in this study, we seek to establish whether employers’ demand for self-
funded coverage is price responsive and to determine the degree to which employers face
elastic or inelastic demand for this type of health plan. Moreover, we attempt to compare
the obtained measures of the price elasticity of self-insured health plans to previous
literature on the subject across various types of health insurance. In particular, the
methodology used in this study draws upon the methodology used by Phelps (2002) who
defines the price of insurance as “the ‘loading fee’ of the insurance company above
expected benefits” that predominantly refers to the administrative costs of insurance.
Hence, the administrative costs associated with operating self-funded health coverage are

3 There are, however some studies they found elastic estimates with respect to the price, such as the work
by Royalty and Solomon (1999) that will be analyzed in more detail later in the paper.
4 For the literature review of empirical studies of the price elasticity of demand for special types of health
care, refer to Ringel and Hosek (2002).

3

recognized as its implicit price. Further, following Thorpe (1992), the administrative
costs of self-insured health plans are expressed as a fraction of incurred benefits claims in
order to capture the administrative spending more appropriately.

As such, this paper extends earlier work to a new setting of self-insured health plans. The
motivation for that is the prevalent role of self-insurance in the employer’s health benefits
provision (Henderson 1999; Park 2000; Employee Benefit Research Institute (EBRI)
2008). In fact, approximately 55 percent, or 50 million, employees and their dependents
are offered self-funded group health coverage through their workplace that represents
over one-half of all private insurance (Henderson 1999; Employee Benefit Research
Institute (EBRI) 2008). Self-insurance has become predominantly pronounced in larger
firms (Henderson 1999; Park 2000; Employee Benefit Research Institute (EBRI) 2008).
Specifically, in 2006 approximately 89 percent of workers received self-insured health
benefits in companies with 5,000 or more employees (Employee Benefit Research
Institute (EBRI) 2008). However, some smaller firms choose to self-insure as well
(Henderson 1999) and it is evaluated that they (e.g., companies with an employment
below 100) represent one-half of all self-insuring firms5 (Thompson 1993).

The dominant role of self-insurance offered through the workplace is typically explained
by its costs advantages, as compared to not self-insured health plans, which mainly
results from several exemptions and flexibility features it enjoys. In particular, those
exemptions are in the context of state insurance premiums taxes and compliance with

5 Self-Insurance Institute of America recommends practicing self-funded health plans to any business,
regardless of its size. On the other hand, the National Business Coalition on Health advocates self-
insurance for firms employing between 100 and 300 workers as a minimum.

4

varying state mandates (Self-Insurance Institute of America; Thompson 1993; Acs, Long
et al. 1996; Henderson 1999; Claxton, Gil et al. 2005).6 In addition, other exemptions
refer to holding reserve requirements, mandated benefits’ provision, and consumer
protection requirements (Acs, Long et al. 1996; Claxton, Gil et al. 2005). Flexibility
features, on the other hand, are associated with the plan design (Self-Insurance Institute
of America; Thompson 1993; Claxton, Gil et al. 2005) and helping employers treating
their employees more equally with respect to health benefits offered, especially when
they are located in several states (Self-Insurance Institute of America; Marquis and Long
1999). That way, self-funding employers have more control over their cash flows. Thus,
the relevance of self-insured coverage offered through the workplace provides a rationale
for additional investigation with respect to its demand responsiveness. As such, the
subject under examination isn’t just important for public policy makers but it is also
highly relevant for employers and employees.

In what follows, we first briefly discuss empirical literature on the price elasticity of the
demand in health insurance mostly with the focus on employer-provided health coverage.
Next, research questions guiding this study are presented in a more detail and are
followed by a discussion of an analytical setup for investigating the price elasticity of the
demand for self-insured health plans. The empirical section also introduces the dataset
and the methodology used. Further, descriptive statistics and empirical results are
reported and analyzed in more detail. Finally, the results obtained in the empirical

6 Thus, self-insured plans are overseen only on the federal level by the Department of Labor. However,
self-insurance may lead to a greater risk if more claims than anticipated need to be paid.


5

analyses are summarized and followed by a brief discussion of possible directions of
future research.

2. Background
In order to understand the need for a new study of health plan elasticities, let us turn our
attention to a brief discussion of the variety of estimated elasticities in the existing work
with respect to subjects examined and their major findings. Appendix A provides an
overview of such major studies that investigated the price elasticity of demand for health
insurance plans with respect to the context studied, data sources, and empirical as well as
experimental techniques applied.

Large number of empirical studies on the price elasticity of demand for health insurance
comes from studies investigating employees’ enrollment decisions when faced with a
choice among multiple health plans offered by an employer (e.g., the demand
responsiveness for various health plans to their price changes) (Holmer 1984; Merrill,
Jackson et al. 1985; Neipp and Zeckhauser 1985; Welch 1986; Marquis and Phelps 1987;
Feldman, Finch et al. 1989; Short and Taylor 1989; Barringer and Mitchell 1994; Hosek,
Bennett et al. 1995; Cutler and Reber 1998; Abraham, Vogt et al. 2002). In those papers,
consumers are presumed to assess health plans available to them based on the expected
utility they gain from them. The evidence resulting from this literature typically implies
that health plan choice is determined by the price of insurance, as well as by cost sharing
arrangements, income, health status, and some demographic characteristics.


6

On the other hand, other research on the demand for health insurance coverage focuses
the price elasticity by studying a particular health plan, which typically relates to varied
or constant coinsurance rates (Manning, Newhouse et al. 1987; Marquis and Phelps 1987;
Manning, Newhouse et al. 1988; Newhouse and the Insurance Experiment Group 1993;
Royalty and Solomon 1999). In general, the price elasticity estimates in both a health
plan choice setting and a particular health plan environment are far from uniform (Figure
1 illustrates the variety of obtained estimates across the literature). In fact, they vary
largely from each other depending on the data source, methodology, and econometric
techniques applied. Overall, the range of the price elasticities estimated here is as low in
absolute value as -0.01 to -0.02 if using the revised estimates in Barringer and Mitchell
(1994) (whereas in their original publication, these estimates range from -0.1 to -0.2).
On the other hand, according to Royalty and Solomon (1999), the highest bound of the
price elasticities was as high in absolute value as -1.0 to -1.8 (if using the logit estimation
method) or -3.7 to -6.2 (if using the fixed effects estimation) whereas Feldman, Dowd et
al. obtained slightly different estimates within the high bound, such as -5.82 for family
coverage and -3.91 for single coverage (1997)7. It should also be emphasized here that
the results mentioned above (Feldman, Dowd et al. 1997; Royalty and Solomon 1999)
represent two studies to the authors’ knowledge that found that employees were price-
elastic with respect to their demand for coverage. That further implies that most of the
empirical work concluded that the price elasticity of demand for health insurance is less
than one suggesting that employees are insensitive to the price changes of health
insurance.

7 Refer to Appendix A for more details on how these measurements were calculated, their general contexts,
and the methodology used.

7

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Year of Publication

Figure 1: Representative Estimates of the Price Elasticity of Demand of Health Insurance
in Existing Literature

Moreover, the interactions of the price elasticity of demand and income (Phelps and
Newhouse 1972; Beck 1974; Newhouse and Phelps 1976; Manning and Phelps 1979;
Manning, Morris et al. 1980; Newhouse 1981) and age (Royalty and Solomon 1999)
have been also examined in the previous literature. The variation of the price elasticity
with income would imply that the rich are less sensitive to the price than the poor,
which was found to be the case in Beck (1974) who used the Canadian dataset.
However, empirical analyses that used the US data concluded either the contrary effect
(e.g., the poor less sensitive to price than the rich) or the problem with inconclusive data
(Phelps and Newhouse 1972; Newhouse and Phelps 1976; Manning and Phelps 1979;
Manning, Morris et al. 1980; Newhouse 1981). On the other hand, Royalty and Solomon
(1999) found the evidence that the price elasticity also depends on the age of an
individual. Specifically, they concluded that older employees are less price sensitive than
their younger counterparts.

8

3. Research Questions and Hypotheses
As already pointed out, the main purpose this paper is to measure the price elasticity of
self-insured health plan(s) and to compare their resulting estimates to those in the
previous literature. Further, since it may be expected that the price elasticity of demand
may vary with income (Phelps and Newhouse 1972; Newhouse and Phelps 1976;
Manning and Phelps 1979; Manning, Morris et al. 1980; Newhouse 1981) and age
(Royalty and Solomon 1999), the interactions between those variables and the price
elasticity are also considered. Thus, the fundamental research questions and the
corresponding hypotheses to be examined in this paper are listed in Table 1.
Table 1: Major Research Questions and Hypotheses Investigated in this Paper

Research Question (RQ)
Research Hypothesis (RH)
1.
What is the price elasticity of
According to the most of the previous literature
demand in self-insured health
findings, the price elasticity is hypothesized to be in an
plan(s), and how does it relate to inelastic range of the demand.
other estimates across studies?
2.
Does the price elasticity of
Based on the previous empirical evidence from the US,
demand vary with income? If
no variation or the opposite effect (e.g., the rich are
yes, then what is the direction of more price sensitive to the price than the poor) is
this variation (e.g., are the poor/
expected (Phelps and Newhouse 1972; Newhouse and
rich more sensitive to the price
Phelps 1976; Manning and Phelps 1979; Manning,
than the rich/ poor?)
Morris et al. 1980).
3.
Does the price elasticity of
The price elasticity of demand is hypothesized to vary
demand depend upon the age
with age. In fact, it is expected to be higher in absolute
and if yes, then what is the
value for younger people (Royalty and Solomon 1999).
direction of this variation?


9

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