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Price-Linked Subsidies and Health Insurance Markups

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 competition, leading to higher markups and raising costs for the government or consumers. However, price-linked subsidies have advantages when insurance costs are uncertain and optimal subsidies increase as costs rise. We evaluate this tradeoff empirically using a model estimated with administrative data from Massachusetts’ health insurance exchange. Relative to fixed subsidies, price-linking increases prices by up to 6% in a market with four competitors, and about twice as much when we simulate markets with two insurers. For levels of cost uncertainty reasonable in a mature market, we find that the losses from higher markups outweigh the benefits of price-linking.

Authors: 
Sonia Jaffe, Becker Friedman Institute For Research in Economics
Mark Shepard, Harvard University
Publication Date: 
November, 2017
Publication Status: 
Document Number: 
2017-084
File Description: 
First version, July 3, 2017