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 choice frictions were removed. In this paper we take the next analytical step and consider how plans would adjust prices if consumer search behavior improved and consumers became more elastic. Margins should fall, leading to additional consumer and government savings. 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 observed premiums are consistent with insurers profiting from consumer inertia. We use the demand parameters and a simple model of firm pricing to approximate how much lower steady state Part D plan premiums would be if consumers were attentive. Our estimates indicate that an average consumer could save over $1000 over three years when firms' lower markups are taken into account. Further, since the government pays three-quarters of the cost of the Part D program, government expenditures would also fall. Our simulations indicate the government could save $1.3 billion over three years, or 1% of the cost of subsidizing the relevant enrollees.