Wednesday, October 9, 2013

Margins on Exchanges

A nice Bloomberg View by David Goldhill offers an Econ 101 lesson in incentives. Though the average subsidy rate to health insurance is limited, the marginal subsidy rate is 100% once consumers hit the income limits -- so many consumers have no incentive at all to shop for lower prices. In turn, this greatly lowers the chance that insurers will compete on price.

Let’s take an example. A family of four at 138 percent of the poverty level ($32,499) has its premium capped at 3.29 percent of income or $1,071. The rest is subsidy. So, if the cost of a silver plan is $10,000, the subsidy for this family is $8,929. A family at 400 percent of the poverty level ($94,200) has to pay up to 9.5 percent of its income for a plan, or $8,949. So the same $10,000 premium carries a subsidy of only $1,051.

But now look at those two families from the insurer’s perspective. A $10,000 plan already costs more than the maximum amount either family would pay. If the insurer raises the premium to $10,001, both families get $1 in additional subsidy. If it raises premiums to $11,000, both families get $1,000 in additional subsidy. In other words, no matter how much an insurer raises rates, a subsidized household pays zero more.

Of course, it takes some cleverness for insurance companies to separate out these now totally price-insensitive buyers from regular customers, and David explains some of the ways they can do so. Having seen the airlines at work, you get a sense of just how clever companies can be. Modern big-data driven marketing is all about careful price discrimination.

A more well known incentive problem: A rule that you must spend 80% of what you take in can limit profits. Or it can incentivize wasted spending.
In what may be the single greatest source of unintended consequences in the Affordable Care Act, insurers are now required to spend at least 80 percent of revenue from premiums on care. Superficially, this means that if they set premiums too high, they will have to eventually refund much of the money that they don’t end up spending on care. But let’s say you’re running an insurance company. You can find ways to spend more money on beneficiaries’ health care -- say, with more generous definitions of free preventive care, more expansive rehabilitation services or higher reimbursement rates on doctors’ services -- and keep 20 percent of the all money you bring in. Or alternatively, you can spend less on care and give refunds. Easy choice.  
Update: I don't know why I didn't think of this before... Cash rebates! Just like credit cards. OK, we can't be so obvious, points on your credit card, free miles, toasters, checkups for your cat...Each dollar added to the premium comes from the government, so attract customers by the closest thing you can get away with to cash back.