Tweaking US health-insurance subsidies could save $3 billion

Megan E. Doherty | Jun 20, 2017

Sections Public Policy

Collections Health Care

Millions of Americans rely on federal subsidies to help pay for private health insurance through the Affordable Care Act (ACA), and many studies have noted the positive role of subsidies in expanding coverage.

But the structure of subsidies can distort plan prices and diminish competitiveness, according to University of Chicago postdoctoral scholar Sonia P. Jaffe and Harvard’s Mark Shepard. Their research suggests that this is correctable: using all relevant information about insurance costs and prices, the government could tweak the structure of subsidies to cut taxpayer costs by 6 percent, while maintaining the same coverage.

The ACA offers consumers subsidies in the form of tax credits for their monthly premiums. Americans who earn between 100 and 400 percent of the federal poverty line are eligible for the subsidies. Those below the federal poverty line qualify for other health programs, namely Medicare or Medicaid. Subsidies make it less appealing to opt out of securing health insurance, and they can’t be used to pay the penalty people incur for opting out.

Currently, subsidies in every state are linked to plan prices, which means that the amount of the subsidy rises and falls in step with the price of the insurance plan. This price-linked approach can shield consumers from sudden fluctuations in plan price—if plans become more expensive, consumers are offered a higher subsidy in accordance with the new price set by insurers.

If subsidies increase along with price, there is little risk of losing customers and a high likelihood of greater government spending, a market distortion.

However, this can encourage insurers to jack up their prices, particularly since many face little competition: in 2014, state ACA exchanges had an average of just four insurers, and 30 percent of consumers had only one or two insurers to choose from.

The researchers find that if subsidies increase along with price, there is little risk of losing customers and a high likelihood of greater government spending, a market distortion. Therefore when markets are stable and prices are not expected to change suddenly or dramatically, it would work better to shift to subsidies that are fixed at a specific level. If the government could predict what the subsidy would be with a price-linked approach, it could “set an optimal fixed subsidy, thereby eliminating the pricing distortion from price-linked subsidies. This would result in lower prices, greater coverage, and a pure gain for consumers,” write Jaffe and Shepard.

Weighing pros and cons of fluctuating and fixed subsidies, the researchers analyzed data from Massachusetts’s subsidized health-insurance exchange, which predates the ACA, as well as from the American Community Survey conducted by the US Census Bureau. The latter allowed them to estimate the share of people who chose to pay the penalty for remaining uninsured, despite the subsidies offered.

Their findings suggest that price-linked subsidies result in prices up to 6 percent higher than would be the case under a fixed subsidy, and 6–12 percent higher in markets with less competition, under a simulation. Six percent would mean another $46 million in annual subsidy cost in Massachusetts, and more than $3 billion nationally.

When prices are stable, the researchers note, shifting to fixed subsidies could allow the government to achieve the same coverage for 6 percent less—or maintain costs but increase coverage by 1 percent. But if prices become unpredictable, fixed subsidies could wind up costing the government more. In that case, Jaffe says, it could help somewhat to use hybrid subsidies that have both fixed and price-linked features.

This study may have useful implications outside of health, for housing subsidies and school vouchers, where the government also subsidizes consumers’ purchases from private providers. If a voucher value is linked to the cost of private education, it risks distorting private-school prices upwards.