A 'Public' Fix for Health Care Need Not Abandon the Market

By Steven Pearlstein
Friday, April 10, 2009

Although the national debate over health-care reform has only just begun, the first battle lines are being drawn over whether there should be a Medicare-like "public" insurance plan to compete with private insurers in a restructured market.

The public plan has already become a political litmus test for the Democratic left, which sees it as the only antidote to a private market that can't be trusted to deliver quality, affordable health care, and for the Republican right, which sees it as the Trojan horse for a government-run health-care system that will raise taxes and ration care.

The first thing to note is that this is hardly the most important issue in health-care reform. It is possible to design a system that could control costs, improve quality and increase access to care without giving everyone the chance to sign up for a government-run health-insurance plan modeled after Medicare. It's also possible to design a system that includes a public option.

The other thing to note is that if by "public option" you mean the current Medicare fee-for-service plan -- a plan that makes no attempt to manage and coordinate care and pay for that care on the basis of the quality of the outcome -- then a public option would be an awful idea and move the system in exactly the wrong direction.

This is not to say that a well-designed public insurance option couldn't become the model that private competitors would be forced to emulate. It could.

One thing we know about private health plans is that they spend anywhere from 12 to 30 percent of what they take in on non-medical costs: marketing, taxes, reserves, underwriting and profit. In Medicare, these "administrative expenses" run about 5 percent.

That doesn't mean that a public plan for the non-elderly would have the same cost advantage. Unlike Medicare, a new public plan hoping to attract paying customers would have to spend some amount on marketing. And like any insurer, it would probably want to invest in systems and medical staff to discourage doctors and hospitals from ordering up unnecessary tests and procedures. At the same time, under most reform scenarios, private insurers would be able to reduce administrative costs by eliminating their considerable underwriting expenses.

Bottom line: The administrative-cost advantage of a public insurance plan wouldn't be as big as Medicare's, but it could still be large enough to help drive down premiums in a competitive insurance market.

The better argument for a public option is that it could provide some serious pricing discipline for a market that suffers from runaway medical costs.

Rapid consolidation has given big hospital chains so much market power that they can effectively dictate prices even to the largest insurers, which know that they cannot compete for subscribers if they don't have the major hospitals in their networks. And in a similar fashion, pharmaceutical companies can virtually dictate prices to insurers for patented drugs if they are the most effective means of treating a particular ailment.

But while hospitals and drug companies often have more negotiating leverage than insurers, it is also true that insurers don't go out of their way to compete on the basis of price. The market in most regions is dominated by two or three big players that have learned they are better off raising prices in tandem than getting into price wars from which only the customers emerge as winners. Rather than compete on price, insurers compete to attract the healthiest patients.

That's why advocates of a public option believe a government insurance plan is needed to bring more robust price competition to the market, using its size to extract lower prices from providers and passing those savings on to consumers. Medicare already effectively dictates the prices it is willing to pay to doctors and hospitals, and there are very few providers who choose to opt out of the system. A public insurance plan for the non-elderly could simply piggyback on those lower Medicare prices.

The problem with this arrangement is that Medicare is so powerful that it can get away with paying only 80 to 85 percent of actual costs, forcing doctors and hospitals to overcharge private insurers to make up the difference. Private insurers fear that if they were forced to compete against a public plan with that kind of cost disadvantage, they would be driven out of the market. And doctors and hospitals warn that, without private insurers to overcharge, they'll wind up out of business, as well.

Uwe Reinhardt, a Princeton University economist, has a simple fix for this screwy pricing system. Reinhardt suggests that, once a year, each hospital or physicians group come up with a list of prices for individual procedures, or bundles of services, that it is willing to offer to any and all insurers, regardless of size. After reviewing the offers, Medicare and private insurers can then announce what price they are willing to pay and give providers one last chance to adjust their offers accordingly. After that, everyone would be free to do business with whomever they choose on the basis of the posted bids.

There is, of course, a name for such an arrangement. It's called a free market -- in this case a market open to multiple buyers and sellers with regular bidding and transparent pricing. More to the point, it is a market that would work whether there was a public insurance option or not.

Like it or not, fixing our overpriced, under-performing health system will require substantial new government involvement in the markets for health insurance and medical care. Beyond that, however, there remains plenty of room for healthy debate on what form that government involvement should take.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

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