How Should Health Insurance Subsidies be Set?

Fixed and price-linked subsidies called into question.

With GOP lawmakers working to replace the Affordable Care Act (ACA), health insurance subsidies have come into question. Due to a large majority of individuals receiving federal subsidies to supplement insurance costs, there is significant risk for patients to lose coverage.

In a new study published by the National Bureau of Economic Research, economists analyzed the effect different subsides have on healthcare markets, in terms of insurers and competition.

“A few years ago some key economic concepts were missing from much of the debate around the Affordable Care Act,” said study author Sonia Jaffe, PhD. “We wanted to revisit this question of the optimal subsidy structure from a framework of how economists think about incentives.”

The authors investigated the implications of basing subsidies on prices set by insurers, and the implications of basing them off external benchmarks.

Since the enactment of the ACA, millions of Americans have been able to purchase insurance with the assistance of subsidies that are based on the pricing of plans. The study authors said that the price-linking approach can reduce sticker shock and account for market uncertainty because subsidies are based on costs.

However, price-linking can encourage insurers to increase prices, especially if they are the only ones selling plans in a certain market. If demand stays the same, insurers can cost the federal government millions of dollars in unnecessary subsidy payments. This can even happen in less extreme cases where there is little competition, according to the study.

A proposal to replace the ACA has suggested linking fixed subsidies to healthcare inflation, which could lead to lower prices and smaller increases in a single-insurer market.

However, the uncertain nature of the healthcare market may harm individuals with high costs, and result in higher government spending on subsidies if prices decrease, according to the study. Despite market uncertainty, the study authors hypothesized that fixed subsidies would be more beneficial compared with a price-linking approach.

The investigators used data gathered from the Massachusetts exchange to determine the risks and benefits of both types of subsidies. First, they assumed costs are as expected by regulators, and then considered situations when market costs deviate from the expectations.

The simulation showed that subsidies linked to prices can increase costs more than they would for a fixed subsidy. In 2011, when subsidies were linked to prices, costs for the cheapest insurance plans increased 6%. The investigators believe this occurred because the companies could raise prices without losing customers, according to the study.

While the difference seems small, the investigators found that it increased annual subsidy costs in Massachusetts by $46 million. If applied to the whole country, the increases would have cost $3 billion in additional subsidy payments.

If costs are as expected, fixed subsidies reduce customer and government costs. However, if market prices diverge from expectations, price-linked subsidies are more cost-effective, since they respond to costs and ensure that enrollees remain covered despite unexpected price increases, according to the study.

“There are tradeoffs between the two subsidy policies. If set intelligently and adjusted yearly to reflect local health care prices, fixed subsidies could lower costs,” Dr Jaffe concluded. “However, if fixed subsidies are set too broadly or just linked to inflation, they will likely be worse than price-linked subsidies in the long run.”