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.