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Too Many Choices

Why seniors won’t sign up for the Medicare prescription drug plans.

Click on image to enlarge. Illustration by Robert Neubecker.

The new Medicare prescription drug plan will save senior citizens billions of dollars, so why are so many of them afraid to sign up for it? You wouldn’t think such a beneficent program would have to put a metaphorical gun to people’s heads (in the form of a 1 percent per month premium penalty) to get them to enroll now. Yet that is what seems to be happening. Senior citizens are confused. The government has turned the insurance companies loose, with the result that in some states there are more than 50 plans to choose from—all of them complicated—and nowhere is there a simple metric that people can use to determine which plan is best for them.

Befuddled seniors are clutching their heads and asking someone, anyone (their pharmacists, their kids, AARP) for help. Some of them will end up avoiding the plans entirely—and missing out on big drug savings—because they can’t figure out which plan to pick.

This reaction to the drug plan was completely predictable based on modern research in the psychology of decision-making, sometimes called “behavioral economics.” There is now ample evidence that when you increase choice by offering more and more options, a point is reached at which paralysis rather than “freedom” is the result. This is true of trivial consumer choices, such as which flavor of jam to buy, and of extremely consequential choices, such as which 401(k) funds to put your retirement money in.

Indeed, the 401(k) story is remarkably analogous to the new prescription drug plan. Columbia University social scientists Sheena Iyengar and Wei Jiang found that as companies did their employees a “favor” by offering more and more mutual-fund options for their 401(k) contributions, fewer and fewer people elected to participate. Participation dropped 2 percent for every 10 options offered. And, analogous to the Medicare drug plan, by not participating, employees were giving up “free money” in the form of an employer match. It was so hard to decide which funds that employees chose “none of the above.” Employees were so worried they would make a bad choice that they made the worst choice—opting out. And even among those employees who realized that it was foolish to opt out, Iyengar and Jiang found another interesting result: As the number of mutual-fund options increased, the percentage of employees choosing ultraconservative money-market funds rather than equity funds also increased. Any investment adviser will tell you that this is the worst choice you can make for your retirement plan, unless you are old enough to be nearing retirement. So, as the number of options increases, fewer people opt in at all, and more who opt in make poor decisions.

We can expect both of these things to happen with the prescription drug plan. Many people who would be well-served to sign up for some plan—any plan—won’t. And many of those who do sign up will choose poorly. To simplify a hopelessly complex task, people may choose solely on the basis of price (take the cheapest) or on the basis of brand (choose a plan offered by a company you’ve heard of).

The pity in all this is that the prescription drug plan is being unveiled at precisely the time when the financial-services industry, having learned what choice overload does to people’s ability to make good decisions, is changing how it does business, so people can manage the options they are offered. As documented by Carla Fried in the Nov. 13 New York Times, more and more employers are embracing automatic employee enrollment and offering what are called “lifestyle funds” that put a mix of stocks and bonds into a single package so employees don’t have to choose. Both of these moves are driving up employee participation and driving down anguish. Fidelity, the huge mutual-fund company, was a bit ahead of the curve when it introduced such lifestyle funds a few years ago. The modus operandi of these funds is, “Trust us. Give us your money and we’ll keep your portfolio balanced, manage risk, and shift to less and less risky holdings as you get older.” In a stroke of sheer brilliance, Fidelity called these funds, in which participants have no choice, “Freedom Funds.” Freedom from choice, not freedom of choice.

It is possible that over time, the drug plans now offered by insurance companies will shake out, choice will be reduced, plans will get simplified, and “trust us” plans like the Freedom Funds will appear and even come to dominate the market because of their attractiveness to Medicare recipients. The pity is that the Medicare prescription drug plan could have been designed this way from the start. Rather than letting insurance companies compete with plans, the government could have simply extended Medicare, offering perhaps a few choices and a simple metric for comparing options. The choices could have been designed to cater to the prescription drug needs of the overwhelming majority of citizens, with “safety features” that prevented people from catastrophic mistakes. Under these conditions, the government could have used its leverage to control drug prices, instead of relying on the insurance companies to do so. And since Medicare is more efficient than any of its private alternatives, there is no reason to think that people would have given anything up (except waste and complexity) if the drug plan had been a government plan. If the government had moved in this sensible direction, it would not now have to cajole and strong-arm people into signing up. Senior citizens would enroll in droves.

Why didn’t it happen this way? The cynic in me imagines that the Bush administration regarded complexity as its friend, since it would reduce enrollment (and costs) and make the drug plan less of a budget-buster. But one needn’t be so Machiavellian. Many conservatives are skeptical that government can do anything right, and they feared that a government-run benefit would bully drug companies and kill the incentives to create new drugs. Beyond this, if you believe that individuals are the best judges of their own welfare, giving them choices does more to enhance collective welfare than any universally imposed government program could, even one that permitted a limited number of options. Competing plans ought to free individuals to pursue their welfare as they see fit.

We now know, unequivocally I think, that this simple belief is far off the mark as a description of the real behavior of real people. While a life without any freedom of choice would not be worth living, it appears not to be true that more choice inevitably leads to more freedom and greater well-being. Indeed, there may be a point when choice tyrannizes people more than it liberates them. The implication of this, both for individuals and for government officials, is that sound social policy cannot consist solely of throwing an ever-greater menu of options at the American people. For the Medicare drug plans, less would be more.