By Eric J. Johnson
FORTUNE -- We now know that 7.1 million people signed up for health care insurance during the Affordable Care Act (ACA)'s initial enrollment period, which ended on March 31. But, what is less well known is the potential financial disaster facing these millions of consumers who have chosen policies during the last six months.
Our recently published research shows that four out of five consumers will choose a more expensive policy than they need. Because of the complexity of the state and national websites, the typical family will overpay by more than $600 a year. For the average earner, that's half a week's salary.
We examined exchanges at the state and federal level to determine how difficult it is to shop for an insurance plan. Choosing a policy on the state and federal websites requires consumers to sort through a sea of information to find the best options. And as a result, a majority of people have trouble assessing the relative importance of monthly premiums, co-pays, and the annual deductible. What's more, consumers tend to overemphasize co-payments and deductibles in their decision-making.
Evaluating the various tradeoffs inherent in these decisions is not intuitive, and knowing how to address them requires a level of financial and mathematical expertise that few people possess. In fact, during our experiment we asked Columbia MBA students, a group that is quite good at crunching numbers, to find the cheapest policy: More than one quarter got it wrong, and those who got it right told us they needed a spreadsheet to do the proper calculations.
We then added in monetary incentives to see if this would improve decision-making performance. Participants were offered $1 for correctly identifying which plan made the most economic sense for them, as well as entry into a lottery for an additional $200. The failure rate remained overwhelming, with nearly 80% of participants choosing a plan that costs more than they need to spend. Ironically, our financial incentives were modest compared to the built-in incentive: If consumers in this portion of the study had chosen correctly, they would have saved more than $400 annually anyway.
Is the idea of having people choose their own health insurance a bad idea? Only if you insist on having them do so without some help.
Any website could help perform the necessary calculations, just as Amazon (AMZN) does when calculating what shipping, handling, and tax would be for a purchase. And like Amazon or Netflix (NFLX), the exchanges could make suggestions about what policies are selected by people matching your criteria. When we offered tools like this in our studies, ordinary people make choices that are much better, reducing their mistakes to performing as well as our MBA students.
The ability to control one's own retirement savings initially had similar challenges. Consumers had difficulty deciding how much to set aside every month, which is a lot like choosing how much to spend on health insurance per month. They equally struggled with dividing their savings between stocks and bonds appropriately, a similar process to selecting levels of health coverage. That is why, in 2006, the Department of Labor proposed rules and Congress passed the Pension Protection Act to help people make cost-effective retirement decisions. Doing for health care exchanges what that law does for retirement and what Amazon and Netflix do for consumers seems a wise investment
Regardless of your feelings about the ACA, our research concludes that consumers need a similar level of help in making these health choices as they do for retirement. This could include providing estimates of how much insurance someone typically needs, providing point-of-purchase definitions and tutorials online, providing calculation tools which estimate the total cost of each policy and "smart defaults" that suggest choices for consumers based on their needs and financial goals.
Finally, we need to think about how many choices to provide: More choice might be better, but if a site provides over 100 options, as do some states, can we really expect people to make good choices? Or will they simply give up?
The complexity of the ACA exchanges and of health care insurance itself -- plus the all-too-human lack of understanding of math and risk -- means that over this first open-enrollment period many consumers have chosen blindly from a blizzard of bewildering health care options. The result is unnecessary economic costs for the American taxpayer to the tune of $3 billion per year. Solutions exist today to help consumers properly identify the best health care coverage for them and their families.
We need to see past the short-term controversies and help people select wisely.
Eric J. Johnson is a professor at Columbia Business School where he is the inaugural holder of the Norman Eig Chair of Business and director of the Center for Decision Sciences. His research examines the interface between behavioral decision research, economics, and the decisions made by consumers, managers, and their implications for public policy, markets, and marketing.
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