Price-Linked Subsidies and Health Insurance Markups

Sonia Jaffe and Mark Shepard
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Mark Shepard: Harvard University

Working Paper Series from Harvard University, John F. Kennedy School of Government

Abstract: Subsidies in many health insurance programs depend on prices set by competing insurers ? as prices rise, so do subsidies. We study the economics of these "price-linked" subsidies compared to "fixed" subsidies set independently of market prices. We show that price-linked subsidies weaken price competition, leading to higher markups and subsidy costs for the government. We argue that price-linked subsidies make sense only if (1) there is uncertainty about costs/prices, and (2) optimal subsidies increase as prices rise. We propose two reasons why optimal health insurance subsidies may rise with prices: doing so both insures consumers against cost risk and indirectly links subsidies to market-wide shocks affecting the cost of "charity care" used by the uninsured. We evaluate these tradeoffs empirically using a structural model estimated with data from Massachusetts' health insurance exchange. Relative to fixed subsidies, price-linking increase prices by up to 5%, and by 5-10% when we simulate markets with fewer insurers. For levels of cost uncertainty that are reasonable in a mature market, we find that the losses from higher prices outweigh the benefits of price-linking.

Date: 2017-01
New Economics Papers: this item is included in nep-com, nep-hea and nep-ias
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Citations: View citations in EconPapers (10)

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