Polarizability, or the tendency of the electron distribution to distort under an electric field, often depends on the local chemical environment. For example, the polarizability of a chloride ion is larger in gas phase compared to a chloride ion solvated in water. This effect is due to the restriction the Pauli exclusion principle places on the allowed electron states. Because no two electrons can occupy the same state, when a highly polarizable atom comes in close contact with other atoms or molecules, the space of allowed states can dramatically decrease. This constraint suggests that an accurate molecular mechanics polarizability model should depend on the radial distance between neighboring atoms. This paper introduces a variable polarizability model within the framework of the HIPPO (Hydrogen-like Intermolecular Polarizable Potential) force field, by damping the polarizability as a function of the orbital overlap of two atoms. This effectively captures the quantum mechanical exchange polarization effects, without explicit utilization of antisymmetrized wave functions. We show that the variable polarizability model remarkably improves the two-body polarization energies and three-body energies of ion-ion and ion-water systems. Under this model, no manual tuning of atomic polarizabilities for monatomic ions is required; the gas-phase polarizability can be used because an appropriate damping function is able to correct the polarizability at short range.