The persistent contribution rate heterogeneity95 indicates that funds experience contribution rate setting power. Possible sources of contribution rate setting power are product heterogeneity, switching costs or search costs. In this chapter, each of the three sources of contribution rate setting power are presented and discussed.
5.1
Product Heterogeneity
If fund characteristics like non-mandatory coverage and other non-contribution rate attributes have an impact on sickness fund choice and if they are the only source of contribution rate setting power, the market functions like the standard textbook model of monopolistic competition. The membership of any fund depends only on its contribution rate level, the level of all other relevant fund characteristics, the market size and the number of competitors, but not on the membership in the previous period.
5.2
Switching Costs
Switching costs consist of the time and monetary costs of the act of switching and the expected costs (or inconvenience) of getting used to the new fund, if switching has taken
place.96 In the context of the German sickness fund market, switching costs can be heterogeneous across time, individuals, and funds of origin or destination, or of any combination of these.
• Heterogeneity across time: Average switching costs are likely to decline over time. The advance of the Internet made the provision of contact information and forms to join another fund easier, thus reducing the time cost of switching. People have also learned from others who have switched funds previously, that the ways different funds operate are quite similar, and therefore the expected cost of getting used to a new fund has probably declined as well. Time invariant switching costs would cause switching to take place only (after the initial adjustment in the first year following the deregulation) if the relative contribution rate between funds changes. Declining switching costs would result in switching from more expensive to less expensive funds even if the relative prices remain constant over time. A widening of the contribution rate spread would accelerate switching, while a narrowing of the spread could either reduce switching or even prevent it altogether.
• Heterogeneity across individuals: If switching costs were homogenous across homogenous individuals, all members of a fund with the same choice set would react the same – remain in their current fund, or switch to the same fund. This is not observed, however. Moreover, given the people’s different abilities to process information, incomes (and thus potential savings from switching), valuation of the time costs of switching, and to complete the required tasks for switching, it is reasonable to assume that switching costs are heterogeneous across people.
96
• Heterogeneity across funds of origin: As the process of leaving a fund is rather simple and standardized, it is reasonable to assume that the switching costs are homogenous across funds of origin.
• Heterogeneity across funds of destination: Switching costs are most likely heterogeneous across funds of destination, because funds attempt, with varying success, to make switching to them easy and thus reduce the costs of switching. For example some post the membership forms on-line and some send out targeted mail. Thus the fund with the lowest contribution rate is not necessarily also the only or even most popular switching destination.
In reality switching costs are likely heterogeneous across people and funds of destination that decline on average over time, but are homogenous across funds of origin. Given the heterogeneous distribution of branches and population97, it is further reasonable to assume that for two individuals g and h that are currently members of fund j, two potential destination funds k and l and switching costs λ, λgk >λhkand λgl <λhl. Thus the order of
funds with respect to switching costs is not identical for all individuals.
The same applies for the interaction of time and individuals98 or time and fund of destination.99 Thus the switching costs can be written as
JT jt IT it IJ ij T t J j I i ijt λ λ λ λ λ λ λ λ = + + + + + + (20)
97 This is not restricted to the pure geographic distribution, but has to be understood in a broader sense. For
example some individuals are “closer” to one fund than another, because they know members or employees of that fund or for some reason they feel more comfortable about switching to one fund than to others.
98 For example people that experienced deteriorating health might, against the trend, have increasing switching
costs.
with
λ
being the average switching costs and the other terms are the individual, fund of destination and time variant deviations from the average as well as the deviation of their interactions.1005.3
Search Costs
It is possible that not every person has complete information about all funds’ characteristics at all times, and that acquiring information about funds requires time and/or monetary effort. If so, the individual might either make decisions with incomplete information about the funds that he considers101 or choose only within a subset of the legally available choice set. If search costs are the only source of contribution rate setting power, every insured person strictly joins the fund with the lowest contribution rate that he is aware of and which is in his choice set.102 Thus fund membership is a function of the fund’s relative contribution rate rank and the fund’s lagged membership103 among all competitors, if the chance of an insured knowing a fund’s contribution rate is independent of any fund characteristic. Realistically, however, certain fund characteristics may increase the likelihood of being in someone’s aware set. The larger a fund is, the more likely it is that someone will hear about the fund through social interaction or the media. Funds with particularly low contribution rates are likely mentioned in the periodically published contribution rate surveys
100 IJT ijt
λ
is omitted, because the other terms are sufficient to identify every individual’s switching cost to any fund at any time.101
This applies if there is more than one fund parameter to know, for example in a mixed form of search costs and product heterogeneity.
102 The subset of the choice set is called “aware set” for the remainder of this research.
103 This is because every insured knows at least his own fund’s contribution rate or if he does not know any
fund’s rate (not even his own), the likely default is that he remains in his current fund. Zok (2003) reports that a surprisingly large number of insured did not know their current fund’s contribution rate.
that often list only the lowest rate funds for a market, and funds that change their contribution rate against the trend will also might also experience more media coverage than other funds.