NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Price-Linked Subsidies and Health Insurance Markups

Sonia P. Jaffe, Mark Shepard

NBER Working Paper No. 23104
Issued in January 2017, Revised in July 2017
NBER Program(s):Health Care, Industrial Organization, Public Economics

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.

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Document Object Identifier (DOI): 10.3386/w23104

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