Public option in private insurance

Mar 6 2012 - 2:35pm

During the debate on the health care bill in Congress in 2010, Republicans and some Democrats vehemently opposed the inclusion of public option in the provision of health care insurance for non-seniors.

The opposition from the health insurance industry was expected, but the opposition to the public option from the Republicans in Congress expanded to include the entire health care bill. Finally, the Affordable Care Act (ACA) of 2010 passed, but without the public option and support of all the Republicans in Congress.

The main argument against the public option was that it would be unfair to the private insurers, because they would be at a disadvantage to compete with the government-subsidized health insurance. Furthermore, opposition in Congress, especially Republicans, argued that government intervention in the private market amounts to creeping socialism, creating inefficiencies and resulting in increasing cost of health care. The opposition groups, so fearful of socialism, did not realize that Medicare for seniors, Medicaid for low-income Americans and health care for veterans are actually part of the public health insurance system. There was at least an option of public health insurance in the original health care bill for other Americans who do not meet the requirements of existing public insurance programs.

In the August 2011 issue of The American Economic Review, authors Randall Cebul, James Rebitzer, Lowell Taylor and Mark Votruba (CRTV) present very convincing arguments, supported by their meticulous empirical analysis, in support of the public option in health insurance plans in the insurance market. This study undermines some of the myths propagated by Republicans, Tea Party loyalists and current Republican presidential candidates.

CRTV investigate the private insurance market in the presence of "search frictions." For a significant majority of people under the age of 65, health insurance is provided through group plans purchased by employers. Health insurance is a complex service involving a multiplicity of factors. Employers, especially small size employers, face a complicated task of shopping for insurance. They have to make comparative decisions among insurance policies and companies regarding drug coverage (brand name, generics and formularies), network of pharmacies, doctors and hospitals, copays, deductibles and other fees.

In fact, a service industry, with health insurance brokers, has developed to facilitate choice among policies. Search frictions, according to CRTV, increase the administrative-health insurance cost to employers. Let me summarize their findings:

First, search frictions result in disparity in insurance premiums for identical policies, and employer groups' premiums are higher (due to monopolistic power) than what a purely competitive market will produce. Due to lack of competition in premiums, insurers engage in a "marketing arms race," resulting in excessive spending on marketing strategies to attract clients. The excess of premiums above the competitive market premiums entails transfer of monetary benefits of consumers (termed as consumer surplus by economists) to insurers, amounting to $34.4 billion in 1997. A study by Leemore Dafny in The American Economic Review, September 2010, also shows that insurance companies engage in price discrimination.

Second, there is a significant turnover in policies (an average of 20 percent per year), since employers, in their quest for seeking less expensive policies, drop insurance for the entire group of employees. High turnover increases administrative cost of insurers and lessens incentive to invest in preventive health care, thus undermining quality of care and disease management (including chronic diseases). In The Journal Economic Perspectives, Fall 2008, CRTV cite sa 2007 Commonwealth Fund Report that finds that if the U.S. spends the same amount on administrative cost as Germany and Switzerland, it would save $32 billion to $46 billion a year. Both Germany and Switzerland have a mixed private and public health insurance systems.

Finally, CRTV finds that a socially optimum government policy would be to subsidize a public health insurance option. It would displace the highest-priced policies and would reduce incentive to private insurers to engage in excessive marketing campaigns, thus improving market efficiency. It would also make private insurance more attractive to consumers by narrowing the dispersion of premiums and bringing premiums much closer to the competitive market price.

Our current private health insurance system also hinders mobility of labor and causes dispersion in unemployment rates across cities and states. A public option, besides improving efficiency in health insurance market, would also improve efficiency in labor markets by promoting labor mobility. We should also not forget that healthy people are productive people.

It is ironic that Rep. Paul Ryan has now proposed with Sen. Ron Wyden a new Medicare plan for seniors in which private health insurers will compete with the current Medicare plan. Rep. Ryan, however, joined other Republicans in denying a public option for non-elderly Americans in the ACA. This double standard is not only inequitable but also inefficient. All politicians and policy makers must base their decisions on unbiased facts, not on ideologies and fear-mongering about socialism. Congress should reconsider including the public option in 2012.

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. His articles also appear at vijaykmathur.blogspot.com. He blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

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