Why Congress Should Restrict the Public Option

09/26/2009 05:12 am ET | Updated May 25, 2011

Despite being only one component of the current health care legislation, the public option continues to generate heated debate from both sides of the aisle. Many of those who support reform see the public option as an essential way to keep insurers competitive and provide an affordable coverage option to the uninsured. Opponents fear that the public option will undercut the private insurance market leading to the collapse of private insurers and the establishment of a single-payer system.

While I think that references to "Nazi policies," "death panels," "tax-funded abortions," and "coverage for illegals" are completely bogus, I am prepared to admit that I think that there is some truth in the arguments from both sides of the public option issue. I also think I have a workable solution to allay everyone's concerns.

Let's start with some basic premises:

  • The current system is not working well for everyone (i.e., the un- and under-insured)
  • Private health insurance is a business with the priority to make a profit
  • Government health insurance does not seek to make a profit
  • Government run insurance has the potential to run private insurers out of business

Okay. Hopefully, we can agree on those four items. Here's why a public option is essential: The market has priced millions of people out. There is demand for health insurance and basic health care that is not being met. In a market, the market clearing price is set such that all demand is met by supply perfectly. We aren't seeing that, which I would assert represents something of a market failure. In such cases, I believe government should intervene. However, my libertarian friends will be happy to note that I think that intervention should be minimal, should only be directed towards those who want help, and should not unduly influence anyone else.

So, the argument for the public option is that it presents a currently non-existent product that will help fill in the gap between public programs like Medicaid and Medicare and private health insurance. This is necessary, because not everyone is offered private health insurance through their employer (especially in the case of small employers), not everyone can afford private non-group health insurance (which is typically very expensive), and not everyone qualifies under the current government programs.

Now, why not just expand the Medicaid program to cover all these people? Well, because it is also believed that providing a public option to compete with the many private options will help to keep private insurers more competitive on the basis of price and benefit quality. It is this public-private competition that raises concerns about the government competing unfairly and putting private insurers out of business. Let's look at that in more detail...

How would the public option undermine the private market? By setting prices so low that private insurers simply couldn't compete with the government plan. At first blush that makes sense, but I see one issue with it. If the public plan is inexpensive, that can only be sustained in two ways: Either it is a bare bones plan that offers very little in the way of benefits, or it doesn't pay providers very much. In the first instance, I think the plan would suffer, because few people are going to voluntarily enroll in a plan with substandard benefits.

The second case -- poor provider reimbursement -- is more likely, but would still hinder the plan. Current Medicare and Medicaid reimbursement rates are below those paid by private insurers, and we know that, as a result, many providers place limits on the number of Medicare and Medicaid patients they will see -- if they see any at all. So, if the public option is inexpensive because it doesn't pay providers well, I think providers will respond by not accepting public option patients, and the plan will suffer.

Now, critics may say that the government could try to require that providers accept public plan patients, but I don't think that makes any sense, because there is no good means of enforcing such a mandate. Hospitals have to participate in Medicare if they want to be able to accept other types of federal funding, but no such situation exists in the case of providers. This argument is, in my opinion, a non-starter.

But what if the public plan is priced reasonably, provides decent benefits, and reimburses providers at a sufficient level to ensure their participation? If the public plan can do all of this and remain less expensive than private insurance, won't people flood out of private plans and into the public option? Yes. This is the economic concept of "crowd out." Of course, the volume of this private-to-public shift is highly price-dependent. That is, more people will go into the public plan the less expensive it is, but only to a point. If it is too inexpensive, then the problems noted above are likely to keep the public plan from working well.

So, how can we put a public option in place, but minimize crowd out? By restricting access to the public option. Specifically, that means limiting eligibility to purchase into the public plan to the following groups: small businesses, the self-employed, and individuals (i.e., the non-group market). Everyone else (i.e., large businesses) would continue to operate just as they do now, by either self-insuring or offering employees a choice of private insurance coverage. It seems to me that an option like this would target the public plan at the groups the market doesn't seem to want and that the government wants to help obtain coverage. At the same time, it would keep private insurers in business, offering products to essentially the same pool of individuals they currently choose to insure.

The one drawback I see is that the ability of government to keep insurers competitive through the public option is diminished in direct proportion to the restriction in consumers' ability to switch from a private to a public plan. Still, as compromises go, I think this is a pretty sound alternative to the current situation.

Other topics of interest on my blog: Ted Kennedy's Death, Gene Taylor Town Hall, and the pick of the week: The Myth-Spawners: They're Not Stupid, Just Evil