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How to Construct Subsidies for Health Insurance

By February 14, 2017Commentary

When consumers are mandated to buy health insurance, which isn’t cheap, many simply can’t afford it.  So it is common for such mandates to be linked with income-tested subsidies, as is the case with the federal health reform law.  Those subsidies can be fixed in some manner or can be linked to the cost of health insurance.  A paper at the National Bureau of Economic Research examines the effects of price-linked subsidies.  (NBER Paper)   Obviously, if insurers know the subsidies rise concurrently with prices, there is an incentive to increase prices to capture more total revenue without loss of customers.  Normally when prices rise, fewer people buy.  On the other hand, not having subsidies tied to insurance premiums means that sudden price shocks could impose unexpected financial burdens on lower-income enrollees, potentially deterring them from even buying health insurance.  And of course, if prices do rise and price-linked subsidies are used, the taxpayers get to bear the burden of increased subsidy spending.  The authors used data from Massachusetts health insurance exchange to evaluate use of price-linked subsidies.

As might be expected, the impact of price-linked subsidies varies depending on market structure.  Where there are insurers, the effect appears weaker.  But in general, this type of subsidy does appear to encourage faster premium increases.  The upward distortion in pricing of the lowest-cost plan, to which Massachusetts’ subsides are tied, resulted in Massachusetts spending about $46 million more on subsidies in 2011, which would have been over $3 billion if extrapolated to the entire country.  When the number of insurers shrinks to two or three, which it has in many parts of the country on the federal exchanges, the price distortions are much greater.  One advantage of price-linked subsidies is that they appear to maintain the number of people with coverage even when there are substantial health cost shocks.  This theoretically maintains a better insurance pool and protects more people from individual health cost surprises.  But under most scenarios, the authors find that fixed subsidies would do a better job of maintaining the balance of lower prices and keeping people insured, not to mention protecting taxpayers.  Kind of an obtuse subject, but one with significant implications for how health insurance systems are designed.

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