Premium Regulation, Risk Equalization, Risk Sharing, and Subsidies: Effects on Affordability and Efficiency

A major challenge in regulated health insurance markets is to design a payment system that promotes both affordability and efficiency. In practice, regulators rely on premium regulation, risk equalization, risk sharing, and various forms of subsidies. This chapter describes the effects of these tools on affordability and efficiency. A first observation is that no single tool is likely to simultaneously achieve the two objectives, which calls for a blend. A second observation is that a smart blend at least includes risk equalization on the basis of exogenous variables, and subsidies from the regulator to either insurers or consumers. However, since exogenous variables do not sufficiently correct for risk variation, supplementary tools in the form of endogenous risk equalization, risk sharing, and/or premium regulation are needed too. Our conceptual exercise shows that choosing the “right” blend involves complex tradeoffs.

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