Price-Linked Subsidies and Health Insurance Markups

Subsidies in the Affordable Care Act exchanges and other health insurance programs depend on prices set by insurers – as prices rise, so do subsidies. We show that these “price-linked” subsidies incentivize higher prices, with a magnitude that depends on how much insurance demand rises when the price of uninsurance (the mandate penalty) increases. To estimate this effect, we use two natural experiments in the Massachusetts subsidized insurance exchange. In both cases, we find that a $1 increase in the relative monthly mandate penalty increases plan demand by about 1%. Using this estimate, our model implies a sizable distortion of $48 per month (about 12%). This distortion has implications for the tradeoffs between price-linked and exogenous subsidies in many public insurance programs. We discuss an alternate policy that would eliminate the distortion while maintaining many of the benefits of price-linked subsidies. ∗The authors would like to thank Amitabh Chandra, David Cutler, Keith Ericson, Jerry Green, Jon Gruber, Scott Kominers, Amanda Starc, and participants of the Harvard Industrial Organization Lunch and Harvard Health Care Policy Lunch for their helpful comments, the Lab for Economic Applications and Policy (LEAP) at Harvard University for funds for acquiring the data, and the Massachusetts Health Connector and its employees (especially Nicole Waickman and Marissa Woltmann) for access to and explanation of the data. The views expressed herein are our own and do not reflect those of the Connector or its affiliates. All mistakes are our own. †Harvard University, [email protected]. Jaffe gratefully acknowledges the support of a National Science Foundation Graduate Research Fellowship, as well as the hospitality of the Becker Friedman Institute for Research in Economics at the University of Chicago. ‡Harvard University, [email protected]. Shepard gratefully acknowledges the support of National Institute on Aging Grant No. T32-AG000186 via the National Bureau of Economic Research, and a National Science Foundation Graduate Research Fellowship.