09/09/2009 11:21 am ET Updated May 25, 2011

If Done Right, Health Insurance Co-ops May Be Better Than a Public Plan

Of the three types of organizations that provide health insurance -- private corporations, governments, and customer-owned nonprofit co-operatives -- co-ops along the lines of those proposed by Sen. Kent Conrad (D. N.D.) have the potential, if done right, to be most closely aligned with consumers' interests.

Health insurance plans inevitably face tough choices between saving money and paying claims for health-care services when those services may be close to the line between what's covered and what's not.

Private insurers driven by the desire to maximize profits for their shareholders face pressure to make the close calls, and sometimes the not so close calls, in favor of denying claims. Hence the health insurance horror stories that occur all too frequently.

A government-run plan may be subject to pressures that distort coverage decisions, too. It may be pressured to deny coverage for procedures opposed by powerful political interests (abortion or stem cell treatments, for example). There's also the risk that a government plan could be saddled with leadership by incompetent political cronies -- if a President can have a horse-show guy in charge of emergency management during Hurricane Katrina, anything is possible. Progressives who insist upon a government option would do well to remember the quality of government we endured over the past eight years. (Remember, the government-run plans now being considered differ from Medicare in important ways: like private plans, they must be paid for by premiums and negotiate reimbursement rates with providers; and they may lack the political clout that senior citizens have used to protect Medicare.)

A nonprofit co-op accountable only to its members is in a better position to decide how best to balance coverage and cost. It can hire its own doctors and nurses and employ the comprehensive approaches successfully used by the Mayo Clinic and similar providers to reduce costs and achieve better outcomes. And a co-op may also offer a better opportunity for encouraging the preventative care, healthy lifestyles, and wellness programs that cut health-care costs, because the savings generated by these activities can be passed directly to members, rather than being paid to shareholders (in the case of private plans) or to the Treasury (in the case of government-run plans).

But as a study funded by the American Medical Association concluded, huge private insurers dominate many local markets, and new entrants face significant hurdles, including the high costs of signing up customers and developing networks of local providers. So to be successful, co-ops must be structured to compete against huge private insurers while preserving the membership control that will protect patients' interests.

Here are a few of the key elements of what is needed to make a co-op plan successful:

Size Matters. Co-ops must have enough members to be able to pressure health-care providers for cost-saving deals. A 2000 study of co-ops by the Government Accounting Office found that smaller co-ops lacked the bargaining leverage with providers necessary to drive down premiums.

Membership-Elected Board. It's reasonable for the co-ops' initial board of directors of to include representatives of the federal government, since the taxpayers will have such a significant stake in the co-ops' success. But once they are up and running, the co-ops' boards must be elected only by their members. That's the best way to ensure that management only takes into account the members' interests.

Adequate Start-Up Capital. This is one of the most important elements. The co-op must have enough money at the outset to hire top-rate management, put in place all the necessary "backroom" systems, develop provider networks, and sign up members. I'm no expert on this (and Congress will undoubtedly consult some), but it is reasonable to assume that billions of dollars of start-up capital will be required. Without adequate start-up capital, the co-op option is doomed to fail.

What Kind Of Capital? The federal government is expected to provide the start-up capital, but what form should it take: equity, a grant, or debt? Equity makes little sense because the co-ops will be non-profit, and the whole idea is to keep the co-ops aligned with their members' interests and away from government pressure. A grant seems too generous, since there is no reason why a viable co-op shouldn't be able to repay the taxpayers sometime in the future. Debt seems the logical choice -- the co-op could borrow the start-up capital from the government on very favorable terms, perhaps a bit over the 30-year Treasury bond rate, and make only interest payments for a lengthy period. Once the co-ops are up and running, they could raise money in the private markets. And the debt approach would leave the government in the lead position if a co-op failed. But failure needs to be an option: Congress should make clear that the co-ops are not backed by the Full Faith and Credit of the U.S. Government -- no more Fannie Maes!

Government Audit. The Government Accounting Office should audit the co-ops to ensure that federal start-up funds are being used only to develop and operate the co-ops.

Bring Providers to the Table. At the outset, co-ops will face a "chicken and egg" problem. Many people and businesses won't enroll in a plan unless the major providers in their area participate on competitive terms; and the major providers will have little incentive to give competitive terms to the co-ops until they have the bargaining leverage that comes with lots of insureds. A short-term regulatory solution known as a "Most Favored Nation clause (MFN)" seems like the best way to solve this conundrum: For the first few years, major providers that receive federal dollars should be required to give co-op insurers business terms no less favorable than those offered to other insurers in their area. That will enable the co-ops from their inception to offer health insurance at or below market rates and thus to attract lots of members. Once the co-ops have enough members, they will be able to use their bargaining power to drive costs down and to improve care, without the continuing need for the MFN.

How Many Co-ops? There is a tricky trade-off here between ensuring that co-ops have the size and scale to compete effectively against huge private insurers while being responsive to local needs. Because of the high initial cost of establishing co-ops around the country, it may be best to start with a national co-op that would develop the plans, and require it to establish and spin-off state or regional co-ops down the road.

Co-Ops Are Only Part Of The Solution. Co-ops can only work if they are adopted as part of a comprehensive health-care reform package that includes significant insurance market reforms that require everyone to have insurance and end discrimination against those with pre-existing conditions.

For many of us who came of age in the 1960s and 1970s, member-run co-ops represented an idealistic alternative to both corporate power and unresponsive government. Today, there are co-ops in a broad variety of businesses, including banking, outdoor equipment, and, yes, health insurance. If done right, there's no reason co-ops can't compete effectively against private insurers, not only on price, but on coverage and service, resulting in enhanced choices that will bring about lower costs and better coverage for consumers.

A former Supreme Court law clerk, chief counsel on the Judiciary Committee staff of Senator Edward M. Kennedy, and deputy assistant attorney general in the Antitrust Division in the Justice Department during the Clinton Administration, Jeff Blattner is a lawyer in Washington, DC specializing in competition policy. He has not been engaged to work on the current health-care reform effort. The views expressed are his alone. [Note: several years ago Jeff represented the American Association of Medical Colleges and the American Hospital Association on a matter unrelated to health-care reform.]