Corporate & Securities Law

Rebutting the Arguments for a Public Health Insurance Option

A few days ago, Robert Reich had an op-ed in the Wall Street Journal entitled Why We Need a Public Health Care Plan. I had hoped to respond, but I’m a bit consumed with summer research right now. Fortunately, Friday’s Journal included an op-ed by John Calfee, The Dangers of Fannie Mae Health Care, that persuasively and eloquently responded to Reich’s arguments. If you’re at all interested in this topic (and you should be, as the matter will substantially affect your life and is proceeding through Congress with disarming speed), please read both pieces.

Reich sets forth all the standard arguments in favor of the public plan:

(1) It will enhance competition among insurers, leading to better insurance products. (”As a practical matter, the choice people make between private plans and a public one is likely to function as a check on both. Such competition will encourage private plans to do better — offering more value at less cost.”)

(2) It will have lower administrative costs than private insurers. (”[Insurance company critics say that] the public plan starts off with an unfair advantage because it’s likely to have lower administrative costs. That may be true — Medicare’s administrative costs per enrollee are a small fraction of typical private insurance costs — but here again, why exactly is this unfair? Isn’t one of the goals of health-care cost containment to lower administrative costs?”)

(3) It will not need to earn profits and can thus provide a cheaper offering. (”[I]f nonprofit plans can offer high-quality health care more cheaply than for-profit plans, why should for-profit plans be coddled? The public plan would merely force profit-making private plans to take whatever steps were necessary to become more competitive.”)

(4) It will have economies of scale that will permit it to negotiate favorable reimbursement rates from providers. (”Being the one public plan, it will have large economies of scale that will enable it to negotiate more favorable terms with pharmaceutical companies and other providers.”)

(5) Because it’s optional, it can’t really hurt anybody because people can always just choose a private insurer. (”It’s an option. No one has to choose it. Individuals and families will merely be invited to compare costs and outcomes. Presumably they will choose the public plan only if it offers them and their families the best deal — more and better health care for less.”)

Calfee takes on each of these points.

With regard to the “enhanced competition” argument, Calfee points out that there is already vigorous competition in the health insurance industry. Adding one more player won’t noticeably enhance competition. As he notes, “Hundreds of health insurance plans already exist, and employer benefit managers can choose among numerous alternatives. There is no lack of firms willing to compete to provide health insurance.”

In response to the “lower administrative costs” argument, Calfee observes that government-run enterprises, which need not earn a profit or even break even, are almost always less — not more — efficient than private businesses:

Would a public plan have lower administrative costs? Well, how often are public enterprises run more efficiently than private ones? Why did practically all economically advanced nations dismantle their public airlines, phone companies, and so on, invariably obtaining lower administrative costs and consumer prices?

As Stanford University health economist Victor Fuchs has pointed out, what “insurance” firms actually sell to large employers — which account for the single largest segment of the entire health-care market — is usually administrative services, not actual insurance. (Large companies are not insured; they pay benefits directly.) There is no reason to expect a Medicare-like public plan to match the administrative efficiency of Aetna, Blue Cross-Blue Shield, Cigna, UnitedHealth Group, and WellPoint. Medicare doesn’t even try. It outsources most administrative services to the private sector.

Turning to public plans like Medicare and Medicaid for more efficient administration is a fool’s errand.

[NOTE: Calfee could have gone further here. The argument that the public plan would have lower administrative costs than private insurance is based on the bogus claim -- parroted by Reich -- that Medicare has lower administrative costs than private insurance. As Robert Book has recently explained, Medicare's purported administrative cost advantage is based on fuzzy math. Public plan proponents measure administrative costs not as a dollar amount per beneficiary but as a percentage of an insurer's total outlays (i.e., administrative costs divided by the sum of health benefits paid plus all other costs). This measure gives Medicare an unfair advantage for two reasons. First, the total health benefits paid by Medicare (the bulk of the denominator in the measurement) are much higher than those of private insurers, making the fraction comprised of administrative costs much lower. Medicare patients are by definition elderly, disabled, or patients with end-stage renal failure. They have much higher average patient care costs than the folks covered by private insurance. When administrative costs are measured instead on a per beneficiary basis, Medicare's administrative costs are higher (12.3% higher in 2005, 22.7% higher in 2004, a whopping 48.4% higher in 2000). Second, public plan proponents improperly label some patient care costs incurred by private insurers as administrative costs. To get the numbers the proponents set forth, private insurers' administrative costs are measured by the difference between premiums collected and claims paid. Much of this sum, though, is not "administrative" cost. For example, many private insurers provide disease management services for chronically ill patients and/or on-call nurses that patients may consult by phone. These are patient care expenses, but they're labeled administrative costs under the public plan proponents' formula. In addition, "administrative costs" are taken to include state-imposed premium taxes that private insurers, but not Medicare, have to pay. Nonetheless, even if we include these various costs in private insurers' administrative costs, such insurers are still more efficient than Medicare on a per beneficiary basis. OK... Back to Calfee's rebuttal.]

With respect to the argument that the public plan would be non-profit and thus more efficient, Calfee notes that we’ve already had lots of (disappointing) experience with non-profit health plans:

Nonprofit health insurance firms are common, including many of the Blue Cross-Blue Shield plans. Nonprofit status has not proved to be a reliable source of efficiency and cost-saving. The addition of new nonprofit cooperatives and the like — as a bipartisan group of senators has proposed — would make little difference, unless the new plans are given the power to set prices and take on extra risk supported by government subsidies.

So what about the economies of scale argument? Given the massive size of many private insurers, all scale economies have likely been exploited already. As Calfee explains,

Aetna currently serves about 18 million subscribers, UnitedHealth Care serves between 25 million and 30 million, and WellPoint more than 35 million. That is more than is served by the health-care monopoly of Canada (population 33.6 million), and more than the entire health-care systems of most European nations. Once a plan reaches a few million subscribers, there may not be a lot of economies of scale left that can enable public plans to provide lower prices.

But what about the fact that the public plan is optional? Doesn’t that imply that no real harm can result from offering such a plan? Sadly, no. The major harm from a public option, Calfee explains, will stem from its one feature that will, in fact, permit it to cut health care costs. While a public option can’t cut costs by enhancing competition, reducing administrative costs, foregoing profits, or achieving economies of scale, it will have one cost-cutting advantage private insurers lack: monopsony power. If it exercises that power, though, it will hurt us.

A public option will likely become, very quickly, the nation’s dominant insurer. Having the backing of the federal government, which will certainly not permit it to fail (see, e.g., Fannie and Freddie), and the ability to use government carrots and sticks to negotiate deals with providers, it will immediately have both a lower cost of capital and some negotiating advantages. Taken together, these cost advantages will permit it to enroll most Americans. Indeed, the Lewin Group estimates that 70 percent of the 172 million privately insured Americans would convert to the public plan.

Once that mass conversion occurs, the public plan will have serious cost-cutting advantages that stem from its monopsonist status. Monopsony power is simply the flip-side of monopoly power. Whereas a monopolist (a dominant seller) has the power to drive prices above cost (by withholding its output), a monopsonist (a dominant buyer) has the power to drive prices beneath sellers’ costs (by withholding its purchases).

While an exercise of such power might benefit some consumers, at least in the short term, the long-term effects would be quite negative. Forced to price below their costs, health care providers would quickly begin to cut all expenses unrelated to the immediate provision of services. Most notably, they would cut research and development expenditures, leading to reduced health care innovation. Because the United States is the dominant source of the profits that fund health care R&D worldwide, this would be disastrous. As Calfee explains:

The U.S. is unique because it alone is the source of half of world-wide profits that provide the payoff for the complex, lengthy, and expensive process of developing new treatments. When other nations construct their health-care systems, they ignore the impact of their pricing policies on R&D incentives. As the dominant R&D funding wellhead, we do not have that option.

Competitive markets have generated the prices and the profits necessary to induce a steady flow of medical innovation in this country. A public plan option would tend to dismantle that system. The people in charge will not know how to set reimbursement levels to motivate reasonable R&D efforts, and there is no reason to expect them to try. In public plans, the tried-and-true method is to push the prices of suppliers down until something gives — too few doctors willing to take on Medicare patients, for example — and then to ease up. That is a destructive approach to medical technology R&D.

Who knows what drugs will not be developed if reimbursement levels for a new multiple-sclerosis treatment are too measly? In virtually every advanced economy but our own, pricing authorities simply make sure prices are high enough so that existing drugs continue to be made available. We can expect a public plan here to do the same. The inevitable result is to drastically under-incentivize R&D.

I obviously believe there is a clear victor in the Reich versus Calfee debate, but read both op-eds and decide for yourself. For a price competition-based (not monopsonization-based) approach to reducing health care costs, see here.

Full post as published by Truth on the Market on June 29, 2009 (boomark / email).