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Yes, Mickey, The Public Option Really Is That Important

Jacob Hacker is the Stanley Resor professor of political science at Yale University. Rahul Rajkumar is a physician in Boston, Massachusetts. 

New reports confirm that the Senate Finance Committee, one of five congressional committees writing health legislation, is likely to reject calls to create a public insurance option. That will put it at odds with its counterpart in the Senate, the Health, Education, Labor and Pensions (HELP) Committee, which has called for a public plan. (Two House committees have also reported out legislation with a public plan.)

As a result, this seems like as good a time as any to revisit some of the arguments about the public plan--and one set of arguments in particular in particular.

A few weeks ago, Mickey Kaus posed a few questions on his blog about an article we had written, describing what the world would look like without a public option.  (Mickey, we admit that the economics of insurance markets can be boring stuff, but we're glad you were "galvanized" enough to post a thoughtful response.) 

Here's a response to his questions.

Mickey writes:

"But under the Dem reform plan, even without a public option, wouldn't ‘[i]nsurance companies required to offer the same coverage to everyone, regardless of medical history'? If so, why won't these 59-year-olds with diabetes be able to find plans they can afford as much as 59-year-olds without diabetes?"

We believe that plans should be required to charge the same rate to all people--and to accept all comers, rather than pick and choose people based on their characteristics. (If premiums are allowed to vary across age categories, we would also like to place serious restrictions on how much they can vary.)  But even with community rating and guaranteed issue, we still need the additional discipline of a competing public plan.

To see this, we need to take a step back and think about the three main markets in which people get insurance today. (1) the individual market, where people buy coverage on their own; (2) the small group market, where small employers that don't "self-insure" buy insurance for their workers; and (3) the large self-insured group market.

The individual market is the Wild West of insurance, featuring the highest administrative costs, most aggressive underwriting, and most egregious practices. The small group market is not the Wild West. It's more like one of those frontier towns with a corrupt sheriff. You can get coverage here so long as you have a healthy workforce, but it's still expensive, subject to a lot of limitations, and often unstable. Finally, there's the large group market. This market works pretty well because costs are spread broadly across many workers (offering something close to community rating,) and because it offers stable options.  And though it too fails to control costs and improve quality consistently, like the rest of our health care system, it's still the best functioning private insurance market today. That's why we want to provide a similar sort of risk pooling and administrative aggregation for everyone. 

The mechanism for doing this is the insurance "exchange." It would provide group insurance options to small employers and individual workers who lack access to comparable offerings, and it would use something close to community rating. And it would be within the exchange that the public plan that we support would be offered.

So the crucial question is: Will the exchange be the go-to place for those who lack large-group coverage? We think it should be. But that's not where most of the reform proposals are. Instead, they try to encourage workers and employers to go into the exchange by providing subsidies only through it, but don't require purchasing coverage through the exchange.  This means that there is likely to be a substantial individual market and small-group market still operating after reform.

The question then becomes how heavily regulated these markets should be. It would be great if there were the same community-rating rules inside and outside the exchange.  But we can't assume that the bill the President signs will include a community rating requirement for the individual insurance and small group markets. 

Indeed, it's more likely that the final bill will end some of the most egregious practices of private insurers without enforcing strict community rating. For one, the legislative language in existing bills is vague enough that it leaves considerable room for interpretation.  For another, it's hard to imagine the private insurance industry will simply roll over without a fight and accept community rating across the board. Right now, their business model is based on selecting for healthy individuals, excluding the sick, and paying out as little as possible in benefits. Getting insurers to accept community rating in the small-group and individual markets would be akin to expecting McDonald's to sell only fat-free Big Macs. (It's instructive that the industry lobby America's Health Insurance Plans, while accepting a limited form of community rating in return for a strict requirement on individuals to have coverage, has resisted across-the-board community rating. And it's not clear how their position may change as negotiations evolve.)

What's more, even if Congress decides to go with community rating, federal and state governments will be charged with enforcing this intent through regulation - and monitoring and enforcement are no small matters when it comes to an industry this resourceful and complex. There will likely be enough ambiguity in the final bill to ensure a game of cat and mouse between the government and private insurers for years. After all, it's not just a matter of getting them to offer the same benefit package at the same price to everyone-though, even this will be no small task-but it also means getting them to offer the same "meaningful coverage" to everyone, not arbitrarily delay and deny care to people with costly and complex conditions, publicly disclose the services they cover and under what circumstances.   

But that's still not the end of the story.  Even with enforced community rating in the individual market, a self-employed 59-year-old will probably still have to pay significantly more than he would if worked for a large employer.  It is true that we've taken his diabetes off the table as a factor, but it's still more expensive to purchase insurance in the individual market.

The exchange will surely do a better job. But even within the exchange, where regulations and monitoring are likely to be most extensive, the rules could vary hugely in effectiveness depending on who's setting the exchanges up, how it's structured, and who's allowed to buy coverage within it. Above all, we think the exchange is likely to work vastly better and be a much more attractive option if it includes a national public plan. The public plan will create a strong competitor that pushes plans to focus on controlling costs and improving value. This will in turn make the exchange more attractive, thus reducing the scope of the less-regulated individual and small group markets. What's more, just having the public plan will allow regulators to go after private plans for bad practices with less concern that they're taking away one of the few good options in an area. And yes, lastly, the public plan will serve as a crucial backup for those ill served by private plans, allowing them to get good coverage on similar terms in all parts of the nation.

This last point does raise the concern that the public plan will get stuck with a higher-risk group, which is Mickey's next question:

"Suppose the public plan uses its purchasing power and lower administrative expenses to cut its prices to 20% below the leading private plans. What will the private plan do? Will it match the public plan by cutting costs-or pursue even more vigorously subterranean strategies to cherrypick the healthiest customers with perks?"

While we can certainly hope that private plans will cut costs, we have to be prepared for the possibility that they'll try even harder to cherrypick the healthiest customers. We don't think that public plan choice can solve all the problems of the private insurance market.  That's why regulating private insurers is so important. It's the combination of a new a public plan and new regulations that we think will really transform the private insurance market.

It's also this combination that will protect the public plan against getting saddled with the highest health risks. We won't dispute that the public plan might end up with a modestly less healthy group of workers. As we argued in our piece, it should be a backup for those who have trouble getting coverage elsewhere. But such modest "adverse selection" isn't likely to diminish the attractiveness of the public plan much, since its premiums are likely to be relatively low for what it offers even with a slightly less healthy mix of enrollees. Extreme adverse selection that really jacks up the cost of the public plan is another matter, but we think this is unlikely to happen.

There are two sides to this concern. The first relates to the exchange rather than the public plan: It is that only the less healthy will seek coverage through the exchange, driving up the cost of all plans within the exchange, public and private.

Again, this dynamic is least likely to occur if the individual and small group markets are required to adopt community rating, which will make coverage outside the exchange less attractive for low-risk groups. In addition, it is not likely to occur if subsidies for coverage for low- and middle-income workers are generous and available only through the exchange. That's because, in this situation, the main reason workers and employers will go into the exchange is because they fall below some income threshold, not because of their health characteristics. Previous studies have shown that there is not likely to be much adverse selection against the exchange if the exchange is attractive to a broad spectrum of low- and middle-income workers.

The second side of the adverse-selection concerns the choice of plans within the exchange. Even if the exchange has a broad mix of health risks, it might be that the private plans will cherrypick the healthiest folks within it. However, this is much less likely to occur within the exchange than it is to occur outside it, because it's within the exchange that the regulations and monitoring will be most extensive and effective.

Moreover, this problem can be addressed within the exchange through risk adjustment. That is, if an insurer enrolls customers that are on average healthier than the others, it should pay a risk adjustment fee to a fund that would redistribute the money to insurers whose enrollees are less healthy. This will substantially reduce the chance that the public plan will be saddled with a highly costly enrollment group for which it does not receive adequate compensation.

Finally, Mickey writes:

"If the disaster starts to happen, we can always set up the public plans later, no?"

In theory, yes, we could just set up a public plan later.  But this strikes us as naive.  This is a once in a generation chance to pass health care reform.  Does anyone really think that we'll get another shot at this in the next ten years?

--Jacob Hacker and Rahul Rajkumar