Price Variation in Markets with Homogeneous Goods: The Case of Medigap

Nicole Maestas, RAND Corporation
Mathis Schroeder, Universitat Mannheim
Dana P. Goldman, RAND Corporation

Abstract

About one-third of elderly Americans age 65 and older supplements their Medicare health insurance in a private insurance market known as the “Medigap” market. Prices for Medigap policies vary widely, despite the fact that regulations enacted in 1992 standardized all Medigap policies, thereby creating a market with homogenous insurance products. Economic theory suggests that consumer search costs can lead to a nondegenerate price distribution within a market for otherwise homogenous goods. Using a structural model of equilibrium search costs first posed by Carlson and McAfee (1983), we find that nearly all consumers face search costs high enough to prevent them from searching until they find the lowest priced Medigap policy. We estimate average search costs to be $249, substantially higher than has been found in other markets, but plausible given the complex nature of the Medigap market and its elderly consumer population. The implied aggregate welfare loss is approximately $798 million or $484 per policyholder.