I'm not going to recap the whole debate but here are a few comments:
1. This is one of the better arguments for health care reform. I don't know how widespread or significant the practice is, but something should be done to stop it. Even if it covers only a small fraction of total medical expenditures, it is a significant moral wrong.
2. I am not convinced by the arguments that reputation provides an effective check on the practice. Reputation affects market practices, but possibly reputation is part of the problem. It's relative reputation which matters. The operative reputational incentive is not always: provide a better product to get more customers. Sometimes the reputational incentive is: customers tolerate bad treatment, because established reputations suggest they will receive equally bad treatment elsewhere.
Some of the used car market works that way too. Why we sometimes get these bad reputational equilibria is a good question and I'd like to see it studied more.
3. That all said, the central question concerns remedies. Presumably the critics believe that egregious violations of law and contract are occurring. If that is the case, why not just enforce the law more strongly and raise the penalties — significantly — for unjust treatment of sick individuals? You can call this market failure, which it is, but it's also legal and regulatory failure as well.
If those legal parties cannot implement and enforce basic laws, can other legal parties successfully take on larger responsibilities for managing the U.S. health care sector? Somehow it is assumed that the answer here is "yes." I'm less certain.
You could try arguing that cases of unjust rescission are not easily observed or verified and thus tougher legal penalties will not work. Maybe so, but then I fear the whole story becomes very muddied: "Rescission — I can't observe it, I can't verify it, yet I know it is true."