Policy Design in Publicly Funded, Privately Provided Markets

Kim, Paul HyungSuk

doi:https://doi.org/10.21985/n2-dac6-qp17

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Policy Design in Publicly Funded, Privately Provided Markets

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Increasingly, governments contract with private firms to provide publicly funded or subsidized goods and services, ranging from defense contracts, social insurance programs to small business loans. In such publicly funded, privately provided markets, governments set specific rules and policies to allow efficient provision or allocation of goods and services. Given the large fiscal spending in these markets, understanding the design of these policies are important. This dissertation examines policy design in the context of three such markets.Chapter 1 studies insurers’ strategic responses to regulations in government health insurance market. Publicly-funded and privately-provided health insurance programs in the U.S. are regulated to ensure a competitive marketplace. However, private firms can strategically respond to government rules and regulations that may lead to market outcomes away from the government’s intended goals. I study insurers’ strategic responses to the interaction of two regulations in Medicare Part D: profit margin regulation and risk corridors (a risk sharing policy). The government utilizes insurers’ self-reported cost estimates to implement both regulations. This creates a trade-off for firms; they can lower their cost report to reduce risk exposure or increase their cost report to charge higher prices. To quantify the effects of insurers’ strategic responses, I estimate a structural model in which insurers are risk averse and can strategically misreport their costs. I find that insurers over-report their cost estimates by 7.5%, leading to 10% higher prices for consumers; however, by over-reporting their cost estimates, insurers are expected to pay back the government 2% of premium revenue in risk corridor payments. Thus, risk corridors limit ex-post profits more than serving as a risk sharing mechanism. I propose an alternative linear risk sharing rule to replace the existing risk corridors, which increases total surplus by 11% while maintaining insurers’ risk exposure. Chapter 2, which is joint work with Anran Li, studies the efficiency of reinsurance subsidy compared to consumer subsidy in the ACA individual health insurance market. First, we develop a model of risk averse insurers that face financial frictions in a market with adverse selection. Using the model, we show that reinsurance has two effects: i) providing cost-subsidy that reduces insurers’ expected cost ii) providing insurance for insurers which reduces risk charge of risk averse insurers. As a result, the pass-through of reinsurance can be larger than one, even in an imperfectly competitive market. We further establish that in a market with adverse selection, it is unclear whether reinsurance or consumer subsidy will be more efficient. Using state-level reinsurance policies, we show empirical evidence of both financial frictions and adverse selection in the market. Many health insurers purchase private reinsurance policies despite high mark-ups. In response to public provision of reinsurance: i) premiums decrease more for insurers that buy private reinsurance ii) premiums decrease more for higher actuarial value plans. Furthermore, insurers are less likely to purchase private reinsurance, reducing insurers’ indirect cost of financial frictions. Chapter 3, which is joint work with David Stillerman, studies the design of the Paycheck Protection Program (PPP), a loan-forgiveness scheme that is implemented through private lenders and assists small businesses in keeping their employees on payroll during the COVID-19 pandemic. We develop a model of PPP lending to capture the government’s tradeoff between inducing bank participation and targeting funds for use on payroll. Using the model, we establish that both increasing subsidies and relaxing forgiveness standards are effective in expanding credit access to borrowers seeking smaller loans. However, their efficacy in targeting (i.e., providing funds to businesses who will use them on payroll) depends on the correlation between loan amounts and borrowers’ return to payroll. We test the implications of the model using policy variation from the PPP Flexibility Act, legislation that relaxed forgiveness standards. Consistent with the predictions of the model, the average loan amount falls by between 6 and 7% in the period following the policy change. Furthermore, marginal borrowers are more likely than inframarginal borrowers to use funds for payroll, so making forgiveness more accessible increases the average share of funds used for those purposes.

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