Under the Affordable Care Act (ACA), many low income consumers will become eligible for government support to buy health insurance. Whether these consumers are able to take advantage of the support and make sound decisions about purchasing health insurance will likely depend on their financial literacy, defined as their knowledge and skills in navigating complex financial products.
We examined the level and distribution of consumers’ financial literacy across income groups, using 2012 data collected in the RAND American Life Panel, a population-representative internet panel. Financial illiteracy was particularly prevalent among individuals with incomes between 100-400 percent of the Federal Poverty Line, many of whom will be eligible for subsidies. In this group, the young, less educated, women, and those with less income were more likely to have low financial literacy.
Our findings suggest the need for targeted policies to support vulnerable consumers in making good choices for themselves, possibly above and beyond the support measures already planned for in the ACA.
The ACA includes incentives for individuals to take up health insurance, including an individual mandate with penalties for noncompliance, subsidies for low-income households, and the health insurance exchanges as new marketplaces where individuals can compare and shop for insurance. The ability of consumers to understand and navigate this new environment, along with the associated rules and regulations, is critical to the intended functioning of health care reform.
This ability is particularly important for low-income households who may be affected by the penalty and subsidy and are likely to obtain their coverage through the exchanges. In particular, the penalty is the higher of a flat fee or a percent of income ($95 or 1.0 percent of income in 2014); households with low incomes are more likely to incur the flat-fee, implying that their penalty is large relative to their income.
Similarly, government support is targeted at consumers with relatively low household incomes (between 100 and 400 percent of the Federal Poverty Line, FPL, or $23,550 to $94,200 annually for a family of four in 2013). These consumers may be eligible to receive premium tax credits and cost-sharing subsidies that are phased out over this income range. Subsidy-eligible consumers who have access to health insurance through their employer will further have to assess whether switching to a plan in the health insurance exchange will be more or less beneficial than staying with their old coverage and thus forgoing subsidies.
These calculations will depend on the available income as well as on family size and available health insurance plans. Experience with other government entitlements, such as Medicaid and the Earned Income Tax Credit, suggest that many eligible households may not take up the subsidies.
In addition navigation of the penalty and subsidy schedules, health plan choice itself may be confusing for consumers. Many have little experience and proficiency with selecting health insurance, a choice of a multidimensional product that requires understanding deductibles, co-payments, out-of-pocket limits and other complex attributes, and then making trade-offs between these attributes given one’s own health needs. Experience is limited even among those individuals who currently have health insurance through their employer, as many of those select their coverage from a limited menu of employer-sponsored plans; in 2012, more than 80 percent of firms offered only one type of plan.
The insurance mandate and potential penalties make it costly not to purchase health insurance, while potential access to subsidies adds to the complexity of choice. Research on employer-sponsored health insurance and Medicare suggests that individuals consistently overpay for health insurance as they give unmerited weight to some plan attributes in their initial choice or do not switch as better choices become available. In one employer-based setting, about one-third of workers were enrolled in a plan that was unambiguously worse than available alternative plans.
Under the ACA, the health insurance exchanges will offer active consumer guidance (navigators, help lines) and passive support (tiers by actuarial value, explanations, etc.) to assist consumers in choosing appropriate coverage. However, comparing and selecting plans can remain a daunting task. The role model for the insurance exchanges, the Massachusetts Connector, offers plans in three high-level tiers of actuarial value: bronze, silver, gold; the ACA adds a fourth tier, platinum. These are further divided into three groups each (low, medium, high) and the Connector screens plans that participate in the program by awarding its “Seal of Approval”.
Evidence of choices in the Connector suggests that consumers struggle to make good choices even in a supportive setting and may use overly simplistic heuristics to guide their decisions. Qualitative work and small-scale experiments indicate the relevance of these concerns to the ACA’s exchanges.
Successfully navigating the penalties, subsidies, and health insurance choices requires sufficient understanding of complex financial relationships. As recognized in research on related areas of financial decision-making, consumers often lack the understanding, ability and confidence to make financial choices that are in their best interest. Consumers’ financial literacy, “the ability to use knowledge and skills to manage financial resources effectively for a lifetime of financial well-being”, has been found to be critical to decisions in areas such as retirement planning, investing and debt.
Financial literacy may also be critical to achieving many of the coverage objectives of the ACA because the decision to purchase insurance or not will depend on financial penalties and subsidies and the choice of a plan will in part depend on expected costs. To shed light on consumers’ ability to navigate the ACA and understand subsidy eligibility and financial consequences of forgoing health insurance, we examined the distribution of a measure of general financial literacy.
To measure financial literacy, we used data from the RAND American Life Panel (ALP), a population-representative online panel. More information on the ALP, as well as the limitations of our analysis, is available in a companion working paper.
We used general measures of financial literacy since, to our knowledge, there are no validated measures of financial literacy in the context of health insurance. General financial literacy focuses on domains such as numeracy, understanding of compound interest and inflation, as well as risk diversification and investing. The associated measures were developed primarily in the context of saving and planning for the future.
We employed a widely used set of three questions on numeracy, inflation, and risk diversification that are shown in Exhibit 1. The questions were designed to assess knowledge of basic concepts of finance. As these measures have been developed in the context of savings and portfolio choice, they do not map perfectly to the choice of health insurance. However, measures of general financial literacy will likely capture individuals’ comfort with complex financial products, which could affect choices about not only saving and investing but also products like health insurance.
We constructed an index of financial literacy from these three questions by counting the number of correct responses for each individual, as is typically done in the financial literacy literature. There was a moderate correlation between the answers to the individual financial literacy questions: the correlation coefficients between the answers to questions 1 and 2, 1 and 3, and 2 and 3 were 0.23, 0.18, and 0.33, respectively.
On average, respondents in the 100-400 percent FPL sample answered 1.9 of the three financial literacy questions correctly, while respondents with income between 400 percent and 1000 percent of FPL answered on average 2.4 questions correctly (see our companion working paper for details). This difference was statistically significant (p-value<0.001). Across all groups of individuals in our sample, the numeracy question had the highest score. Those who did not have health insurance performed worse on all measures of financial literacy, although the differences were not statistically significant.
Differences by income group. Exhibit 2 plots the financial literacy index for groups at different income levels. The figure indicates that general financial literacy increased with income and that this increase flattened out for incomes above 400 percent of the FPL. Financial literacy was particularly low for the population eligible to receive subsidies and most likely to enroll in the exchanges (incomes between 100 and 400 percent of the FPL, as measured in 2012). The empirical pattern suggests that these individuals may have difficulties in responding to the opportunities and requirements of the ACA.
Characteristics of those with limited financial literacy. Exhibit 3 focuses on individuals with incomes between 100 percent and 400 percent of the FPL and compares those with lower levels of financial literacy (0 or 1 question answered correctly) to those with higher levels of financial literacy (2 or 3 questions answered correctly). The young, less educated, women, and individuals with low income were more likely to have low financial literacy. Furthermore, individuals who did not report having health insurance were more likely to have low financial literacy; the difference, however, was not statistically significant (p-value 0.13). In multivariate regression age, sex, education and income remained the only statistically significant predictors of low financial literacy.
Exhibit 3: Characteristics of respondents by score on the financial literacy questions
Exhibit notes: Individuals with income between 100-400% of FPL, weighted. p-values are displayed for testing hypotheses that the differences in means are equal to 0 using t-tests for all items except for education, where Pearson’s chi2 test was used. Source: authors’ calculations using ALP.
The ACA’s penalties, subsidies and health plan choice require consumers to understand and make complex financial decisions with potentially significant consequences. Using nationally representative data, we found that financial literacy increased with income and was lowest among individuals with income less than 400 percent of the FPL. Although the ACA provides this group with subsidies to purchase insurance, their low levels of financial literacy may impede the uptake of this support and, ultimately, reduce the benefits of the ACA to these consumers.