Market Design in Regulated Health Insurance Markets: Risk Adjustment vs. Subsidies
Health insurance is increasingly provided through managed competition, in which two key market design instruments are subsidies for consumers and risk adjustment for insurers. Although typically analyzed in isolation, we illustrate through a stylized model that subsidies offer two key advantages over risk adjustment in markets with adverse selection. First, they provide greater flexibility in tailoring insurance premiums to buyers with different willingness to pay. Second, under imperfect competition, they produce equilibria with lower markups and greater enrollment. We quantitatively assess these effects using demand and cost estimates from the first four years of the California health insurance marketplace regulated by the Affordable Care Act. Holding government spending fixed at approximately the levels in our setting, we estimate that subsidies can increase enrollment by 16 percentage points (76%) over risk adjustment alone, while making all consumers weakly better off.