In Defense of the Public Option

by on August 25, 2009 at 7:10 am in Uncategorized | Permalink

The defense of the public option coming from the administration, Paul Krugman, Mark Thoma and many others is that a public plan would have lower administrative costs and it would discipline the insurance industry.  As stated, I find the argument weak.  The argument, however, begins to make a certain kind of sense when you consider what else the major health insurance reform proposals would do.    

The major proposals would require insurance companies to take all customers regardless of pre-existing conditions, offer guaranteed renewability and no dropping of coverage for the ill, impose no annual or lifetime caps, and offer coverage of preventative care with no-cost share, among other requirements. Finally, if insurance companies must take all customers regardless of pre-existing conditions it is obvious that sooner or later and probably sooner the government will require that everyone purchase health insurance.

In short, insurance reform will mean that everyone will be required to buy a product that will be tightly regulated and more homogeneous.  Both of these factors will increase the market power of insurance firms.  Since escape via non-purchase will no longer be a potential response to higher prices, mandatory purchase will reduce the elasticity of demand giving firms an incentive to increase prices.  Moreover, in oligopolistic markets, a more homogeneous product can increase the ability of firms to collude.

I believe that health insurance reform will increase the market power of insurance firms and drive up prices.  In this scenario, the public option at least has a raison d'etre, although whether it actually fulfills its purpose is an open question.

It's true that mandatory purchase doesn't necessarily lead to market power, auto insurance is quite competitive.  Nevertheless, given the potential of insurance reform to increase the market power of insurance firms the search for some disciplining device like the public option is reasonable.  Other useful reforms would be to have a single, national regulator of insurance – rather than the 50 we have now, allow an optional federal charter (as we do for banks) or (my preferred approach) move to a competitive federalist system for insurance similar to that for corporate charters.

Hat tip to Ray Lehmann for discussion.

babar August 25, 2009 at 7:22 am

what is the backstop if private health insurance companies go bankrupt? will we need a treasury backstop? a bailout like the financial bailout? if so, we need to regulate these firms heavily, just as we need to regulate the banking sector.

SteveC August 25, 2009 at 7:37 am

The reason they point to is the “efficiency” of Medicare. As a % of total premiums collected, Medicare’s expenses are low, but that’s because no one at Medicare questions a bill.

They don’t have a claims department to review bills submitted. They just pay.

Insurance companies have small armies that scrutinize every bill submitted.

Is there any wonder there’s far more instances of fraud with Medicare?

josh August 25, 2009 at 7:56 am

Doesn’t everything you wrote apply to education? Can we draw any conclusions from that example?

AADL August 25, 2009 at 8:33 am

The so-called “public option” has nothing to do with insurance, as any actuary would tell you. It’s a government spending program on healthcare masquerading as insurance.

josh August 25, 2009 at 8:36 am

It may not be “free”, but I expect the public option will operate at a perpetual loss. Don’t you?

matt August 25, 2009 at 8:51 am

So the question is framed as status quo with the public option vs. status quo without the public option. Why ignore the many options of removing the government from healthcare. If you can free up the healthcare market health insurance returns to its proper place as part of the marketplace and not the definition of the marketplace.

Steve C. August 25, 2009 at 9:00 am

Let’s be clear. Describing the public option as a mechanism for improving competition is marketing, pure and simple. One does not compete with government.

Government has

Unlimited resources
Pays no taxes
Is often exempt from the rules it imposes on market players
Has no incentive to improve its output
Responds to the will of politicians, not customers
Can change the rules at any time
Is ultimately backed by the police power of the state

The President can crap in my mess kit, but he is never going to convince me that it’s ice cream.

Brian J August 25, 2009 at 9:14 am

“Medicare doesn’t cover obstetrics, does it?”

Shouldn’t the target audience for Medicare answer this question?

“I know the VA doesn’t.”


Now, two things. First, if the public option is going to be so awful, then people won’t want to sign up for it. Will be they forced onto it? I don’t see why that has to happen, even if firms decide to drop more expensive coverage. Are people prevented from not buying into their company’s policy now and instead using their dollars to buy a different policy? I haven’t heard of that being the case. As long as health care dollars are portable, so that people can buy into whatever policy they like, I don’t see why insurance companies are so scared–unless, of course, they know they are on easy street right now and that some competition would really back them into a corner.

Second, we already have some very recent experiences on which to base our predictions of what a public option would look like. Look at this opinion piece ( about what happened in San Fransisco. There weren’t massive job losses, private options are still there, and while some businesses passed on the costs to consumers, they all did something similar, so nobody was at a disadvantage versus a competitor. Perhaps things will be different in a couple of years, or perhaps things will be different if it’s tried on a national scale, but so far, it looks like it’s working pretty well.

Colin August 25, 2009 at 9:26 am

First, if the public option is going to be so awful, then people won’t want to sign up for it. Will be they forced onto it?

Maybe not forced, but they will provided huge incentives that don’t necessarily make economic sense. Let’s say that we have a public option, that competes on even terms, and very few people sign up for it. There is every reason to think that this would be the case given inefficiencies inherent in government and no obvious competence at running health insurance. This would be a huge embarrassment to politicians and supporters of the public option. Now, which is more plausible, that they would let this program remain as is or would tilt the playing field to ensure that it is able to gain a larger market share?

The answer is obvious, especially when you consider that the public option is little more than a backdoor to a single payer system. How do we know this? Well, the president himself is on record as supporting single payer as well as a number of high-profile Democrats. Plus, if Democrats *really* wanted to increase competition they would simply allow the purchase of insurance across state lines. The fact that this measure — which would cost the government nothing — isn’t on the table speaks volumes.

Then one must also consider that health insurance companies typically have profit margins of around 3%, which is not indicative of an uncompetitive market.

Seward August 25, 2009 at 9:35 am

Since escape via non-purchase will no longer be a potential response to higher prices…

Kind of like how in states which require auto insurance, everyone buys auto insurance. They don’t of course.


Well, if there was really a concern for greater competition then the states would allow for greater freedom to select the healthcare options one wants out of insurance. Instead many states have these gold star requirements for all health insurance plans that one may not opt out of.

Illuminatus? August 25, 2009 at 10:08 am

In Sweden up until 1990 all Swedish Life and pension insurance was strictly regulated and mandated. Insurance companies were prohibited to make profit, they had to operate according to mutual insurance principles.

All insurance companies had to have the same rates and the same underlying actuarial calculations. All marketing material had to have the government required calculations. Insurance companies were prohibited to market that they had lower administrative costs and higher returns.

Sweden deregulated nearly everything in the 90′s including the prohibition on profits in life and pensions. All other restrictions were cut. It lead to poor performing insurance companies to go out of business and an unprecedented cost lowering and product and service innovation.

I cannot understand why the Obama administration and the Democrats want to take the same disasterous route Sweden took for 25 years beginning 1968. Instead the US should take the road Sweden took in the 90s i.e. drastic cutting of personal taxes, cutting business taxes to an effective rate near zero, School vouchers, privatization of social security making it fully funded and with private mutual fund accounts linked, deregualting business and selling all public utitlities.

The US health care debate is a mess. Everybody should acknowledge that Medicare and Medicaid need reform i.e. that rationing is necessary and drastic cost cutting in end of life procedures has to take place. Both the Obama administration and Republicans are delusional in saying that no rationing should ever occur.

Allan August 25, 2009 at 10:31 am

If all companies had to offer the same benefits, why would there be different pricing? That is, how, exactly could companies compete for consumers?

Insurance companies for auto, property, and life do offer different programs. And they get consumers by offering better service. They can do that because they provide the service. For health insurance, the insurance companies would not provide a service (other than paying doctors).

I simply cannot see how the market will function.

Ted Craig August 25, 2009 at 10:41 am

Brian, Maybe you should actually read your links before you post them:

12. Why doesn’t VA deliver babies?
VA covers pregnancy care through arrangements with community providers. VA can pay for prenatal care, delivery, and postnatal care for eligible women veterans, but VA has no authority to provide care to newborn infants. Many details are involved with pregnancy care. Contact a Women Veterans Program Manager as early in pregnancy as possible to discuss local processes regarding prenatal care and to explore options for health care services for the baby. When a pregnant veteran has a permanent, total disability resulting from a service-connected injury, and the child is not otherwise eligible for medical care under the Civilian Health and Medical Program of the Uniformed Services (CHAMPUS), then a newborn infant could receive care under Civilian Health and Medical Program of VA (CHAMPVA).

Ben R. August 25, 2009 at 11:33 am

what is the backstop if private health insurance companies go bankrupt? will we need a treasury backstop? a bailout like the financial bailout? if so, we need to regulate these firms heavily, just as we need to regulate the banking sector.

Haha. Look at the likely bills worming through, and look at the current dire financial straights major health insurance companies are going through as the recession resulted in mass layoffs and benefit cuts.

This is the health insurance company bailout! You now are required to buy their shitty product, probably with direct government subsidy. The public option as it is written is basically a non-entity. A tiny fraction of the public has the option to buy into it, and it’s been written so it can’t undercut private plans. This assumes it is even in the final bill.

What I’d like to see is a cost comparison between this mess – indirectly subsidizing private companies – and just extending Medicare to everyone ineligible for Medicaid. Private insurance doesn’t die in such a scenario, there is plenty that Medicare doesn’t cover.

Alex Tabarrok August 25, 2009 at 11:51 am

FYI, in a competitive federalist system a firm could choose which state to be regulated by but could operate in *any* state – that’s what makes it competitive. This is the system we have for corporate charters. A firm can choose to be regulated under Delaware law or under say New York law but that law applies in all its dealings. See Roberta Romano’s work also relates to Bruce Benson and Hayek’s work on competitive law.

marco August 25, 2009 at 12:26 pm

Tyler … what exactly is the public option?

1) Is it a self-sustaining plan, that can’t run a deficit, and must cover all costs based on the premiums it receives? If not, it’s just another wealth transfer entitlements program.

2) Will insurance companies be allowed to collude, to achieve the same customer pool size as the federal government can achieve; thereby allowing them to get competitive rates from doctors? If not, the public plan isn’t really ‘playing fair’.

PM August 25, 2009 at 12:56 pm

“Note that we get roughly the same overall outcomes at about half the cost, we actually spend less tax money per head on health than you do, while getting far more for our money.”

Repeating memes doesn’t make them come true.

I also would have a very difficult time comparing obesity rates and concluding that they reflect differences in health care. Obesity and overweight is clearly rising around the globe, regardless of the system of health care, and the many if not most developed nations are simply following the U.S. path in a lagging pattern.

David Wright August 25, 2009 at 1:51 pm

Another useful competition-promoting reform would be to open up cross-state insurance, i.e. allow people from California to buy a policy in Virginia, for example. It would allow consumers to get out from under the little politically symbolic regulations that acrue at the state level (e.g. insurance must cover birth control).

Ted Craig August 25, 2009 at 2:12 pm


I consider myself neither a lunatic nor a fool. I do, however, consider you a pompous, uncivil ass, and have for a long time.

Neonatal care may be separate from obstetrics, but it’s an essential and expensive part of the delivery process. So, I’m sorry if my hairs weren’t split well enough for you.

Brian J August 25, 2009 at 2:23 pm


I almost forgot to respond to this:
“Plus, if Democrats *really* wanted to increase competition they would simply allow the purchase of insurance across state lines. The fact that this measure — which would cost the government nothing — isn’t on the table speaks volumes.”

I’ve wondered the same thing. This is drawn from memory, so there’s a decent chance it’s not entirely true, but if I remember correctly, it has something to do with the fact that some states have community rating while others don’t. Of course, if there’s going to be some version of community rating for the entire country, I don’t see why it would hurt to allow this to happen.

Again, I could be wrong, but it does seem like an idea very much worth considering, if enacted wisely. Of course, then the real question is, why aren’t more Republicans offering this type of solution rather than screaming about made up death panels and death books?

Bill Abbott August 25, 2009 at 2:58 pm

Bob Murphy writes:

So Alex, it would be useful to either unify all regulation in the hands of DC, or–your preferred alternative–to move to a competitive federalist system. But what you don’t like is the current system, where there are different regulators in each of the 50 states.


The current system is uncompetitive federalism – 50 different regulators, each with a monopoly in their state. A competitive federalist regulatory system would allow any firm in any state to operate under the regulatory framework of any state of their choice, and consumers in any state free to choose a firm regulated by the state of their choice. This results in competitive pressure encouraging the emergence of efficient regulatory regimes that best serve the interests of the populace.

The likely outcome is a few states ‘specializing’ in health insurance regulation, but with any state free to compete by offering better regulations.

The competitive federalist framework is a great way of dealing with the problems inherent in a monopoly regulatory scheme.

Had the securities and banking sectors been regulated this way, the increased diversity of regulatory structures would likely have reduced the systemic risk in the financial sector.

Serfer August 25, 2009 at 3:51 pm

Ted, Maybe you should actually comprehend article snippets before you post them?

VA can pay for prenatal care, delivery, and postnatal care for eligible women veterans

I don’t know what that sounds like to you, but to me it sounds like they cover most of the costs of a pregnancy including the delivery. What it seems like they might NOT cover are any other issues or complications with the CHILD once he/she is born. And, as noted in the last two sentences, there are additional programs in place to provide for infant/newborn care.

MarkJ August 25, 2009 at 4:21 pm

My obvious question to Obama is:

“If you think ‘public options’ are so swell, why aren’t your girls in the DC public school system?”

george August 25, 2009 at 5:37 pm

Real quick. Definition of free market:
1) no barriers to entry
2) no govt interference
3) no party can influence prices
4) perfect knowledge by both sides (prices, quality, service comparisons)
5) all above-normal profits are competed away by new entries to market

Unless all of the above are met, it is not a free market. Does anyone still think healthcare in the US is a free market? It obviously is not. Besides, if healthcare ever became a free market, with no barriers to entry, it would kill innovation. No investors would touch healthcare without barriers such as patents.

In other words, just get over all the free market will save healthcare BS. It is not one now and never will be.

So the real question is, what model will be the most efficient for the U.S.?


It may seem to Americans that U.S.-style free enterprise — private-sector, for-profit health insurance — is naturally the most cost-effective way to pay for health care. But in fact, all the other payment systems are more efficient than ours.

U.S. health insurance companies have the highest administrative costs in the world; they spend roughly 20 cents of every dollar for nonmedical costs, such as paperwork, reviewing claims and marketing. France’s health insurance industry, in contrast, covers everybody and spends about 4 percent on administration. Canada’s universal insurance system, run by government bureaucrats, spends 6 percent on administration. In Taiwan, a leaner version of the Canadian model has administrative costs of 1.5 percent; one year, this figure ballooned to 2 percent, and the opposition parties savaged the government for wasting money.

The world champion at controlling medical costs is Japan, even though its aging population is a profligate consumer of medical care. On average, the Japanese go to the doctor 15 times a year, three times the U.S. rate. They have twice as many MRI scans and X-rays. Quality is high; life expectancy and recovery rates for major diseases are better than in the United States. And yet Japan spends about $3,400 per person annually on health care; the United States spends more than $7,000.

Brett Dunbar August 25, 2009 at 5:59 pm

The amount of tax money spent per capita on the various state health care schemes (Medicare, Medicaid and VA) in the US is a little higher than the per capita. According to the figures on gapminder.

Heath expenditure, public (% of GDP)

2001 6.3 6.2
2002 6.3 6.6
2003 6.6 7.1
2004 6.9 7.2
2005 7.1 7.2

Heath expenditure, private (% of GDP)

2001 1.3 7.7
2002 1.3 8.1
2003 1.1 8.4
2004 1.1 8.4
2005 1.1 8.3

US GDP per capita is higher than UK GDP per capita, so the difference in cash terms is larger. The US system has gross health outcomes roughly comparable with other OECD countries in all but one respect, cost. The outcomes are about average, the expenditure far higher than anyone else. The US seems to spend very heavily on terminal patients this is very expensive, usually ineffective and often distressing for the patient.

babar August 25, 2009 at 9:13 pm

@andrew: get two, they’re cheap.

Brian J August 26, 2009 at 12:12 am


I understand your point, I just don’t think it really applies. As much as I think there’s political will for reform, I don’t think there is the will for so-called Cadillac benefits for all. So if we get a public option, it’ll probably be something very basic, which is what most people are missing. It’ll be a chance to buy in many haven’t had before, so it’s not as if it has to do much to attract a sizeable population by doing anything other than something basic. In other words, tilting the playing field won’t be an option.

jacksmith August 26, 2009 at 1:17 am

NO CO-OP’S! A Little History Lesson

Young People. America needs your help.

More than two thirds of the American people want a single payer health care system. And if they cant have a single payer system 77% of all Americans want a strong government-run public option on day one (86% of democrats, 75% of independents, and 72% republicans). Basically everyone.

Our last great economic catastrophe was called the Great Depression. Then as now it was caused by a reckless, and corrupt Republican administration and republican congress. FDR a Democrat, was then elected to save the nation and the American people from the unbridled GREED and profiteering, of the unregulated predatory self-interest of the banking industry and Wallstreet. Just like now.

FDR proposed a Government-run health insurance plan to go with Social Security. To assure all Americans high quality, easily accessible, affordable, National Healthcare security. Regardless of where you lived, worked, or your ability to pay. But the AMA riled against it. Using all manor of scare tactics, like Calling it SOCIALIZED MEDICINE!! :-0

So FDR established thousands of co-op’s around the country in rural America. And all of them failed. The biggest of these co-op organizations would become the grandfather of the predatory monster that all of you know today as the DISGRACEFUL GREED DRIVEN PRIVATE FOR PROFIT health insurance industry. And the DISGRACEFUL GREED DRIVEN PRIVATE FOR PROFIT healthcare industry.

This former co-op would grow so powerful that it would corrupt every aspect of healthcare delivery in America. Even corrupting the Government of the United States.

This former co-op’s name is BLUE CROSS/BLUE SHIELD.

Do you see now why even the suggestion of co-op’s is ridiculous. It makes me so ANGRY! Co-op’s are not a substitute for a government-run public option.

They are trying to pull the wool over our eye’s again. Senators, if you don’t have the votes now, GET THEM! Or turn them over to us. WE WILL! DEAL WITH THEM. Why do you think we gave your party Control of the House, Control of the Senate, Control of the Whitehouse. The only option on the table that has any chance of fixing our healthcare crisis is a STRONG GOVERNMENT-RUN PUBLIC OPTION.

An insurance mandate and subsidies without a strong government-run public option choice available on day one, would be worse than the healthcare catastrophe we have now. The insurance, and healthcare industry have been very successful at exploiting the good hearts of the American people. But Congress and the president must not let that happen this time. House Progressives and members of the Tri-caucus must continue to hold firm on their demand for a strong Government-run public option.

A healthcare reform bill with mandates and subsidies but without a STRONG government-run public option choice on day one, would be much worse than NO healthcare reform at all. So you must be strong and KILL IT! if you have too. And let the chips fall where they may. You can do insurance reform without mandates, subsidies, or taxpayer expense.

Actually, no tax payer funds should be use to subsidize any private for profit insurance plans. So, NO TAX PAYER SUBSIDIZES TO PRIVATE FOR PROFIT PLANS. Tax payer funds should only be used to subsidize the public plans. Healthcare reform should be 100% for the American people. Not another taxpayer bailout of the private for profit insurance industry, disguised as healthcare reform for the people.

God Bless You

Jacksmith — Working Class

Twitter search #welovetheNHS #NHS Check it out


Senator Bernie Sanders on healthcare (


ComparedToWhat? August 26, 2009 at 2:15 am

Cheers Alex. I suggest we chose the Japanese approach.

How did Japan manage to avoid becoming a colony? Japanese elites searched the world for best practices, made them known, and adapted them to local conditions.

We should allow the public sector to compete with the “private when profitable” sector.

moi August 26, 2009 at 1:39 pm


Sorry to say, but you don’t know what adverse selection means.

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