Optimal Managed Competition Subsidies

The Medicare Advantage program enables Medicare recipients to receive their health care benefits via private insurance plans instead of through the federal government. Insurers receive a per-enrollee payment from the government, and may add additional benefits and charge an additional premium -- a differentiated products approach which mirrors many other goods provided via a government subsidy. Subsidies are pegged to a measure of the government's cost, but the optimal subsidy in different geographic markets -- conditional on a fixed amount of government expenditures across all markets -- depends on the interactions between consumer demand and supply-side responses to changes in the payments offered by the government. We calculate the optimal geographic subsidy distribution in Medicare Advantage by estimating a flexible oligopoly model that features heterogeneous demand with switching costs, and supply-side price-setting and benefit design behavior. We introduce an equilibrium approximation approach for calculating counterfactual outcomes when the curse of dimensionality prevents a direct search for equilibria. We find the optimal subsidy schedule increases mean consumer surplus by 30% in part by taking advantage of locations where the extensive margin budgetary impact of moving individuals from traditional Medicare to MA outweighs the intensive margin impact of increasing payments for people already enrolled in MA, and in part by redistributing funds to areas where marginal government expenditures result in the greatest increases in welfare. This redistribution is largely driven by differences in firm costs and product characteristics across markets, as opposed to differences in consumer demographics. We explore alternative welfare weights and find policies which are Pareto improvements for consumers.