Sept. 5 (Bloomberg) -- A government-run insurance plan, at the center of a fight over revamping the U.S. health-care system, may fall short of President Barack Obama’s goals for injecting competition into the private insurance market, Harvard Business School economist Regina Herzlinger said.

Republican opponents said during Congress’s August recess that if a government plan can force lower fees on doctors and hospitals, private insurance companies couldn’t compete and would leave the market. Without such advantages, though, a government-run insurer wouldn’t accomplish Obama’s goal of driving down consumer costs, Herzlinger said.

“If they don’t bully the doctors and hospitals on the basis of their massive purchasing power to accept lower rates, where is the economy going to come from?” said Herzlinger, a professor at the Boston business school.

As Congress returns to work next week, the so-called public option is dominating debate over efforts by Obama and Congress’s Democratic leadership to extend health coverage to as many as 47 million uninsured Americans and rein in health-care costs that account for about one-sixth of the economy.

Obama and Democrats in Congress say a government-run plan can help provide choices for affordable health coverage to Americans who don’t get insurance through their employers.

While saying he prefers a public option, Obama has said he’ll consider other ways to foster competition with private insurers such as Indianapolis-based WellPoint Inc. and Philadelphia-based Cigna Corp. Obama plans to address a joint session of Congress on Sept. 9 to seek new momentum for his drive to revamp the health-care system.

Public Option

Some Democrats, and allies such as the AFL-CIO, say they won’t support health-care legislation without a public option. Republicans say the proposal’s threat to drive private competitors out of the market would lead to a federal takeover of the health-care system.

Arguments over government control miss a bigger question about whether a public option would actually spur much competition, Herbert Hovenkamp, who teaches antitrust at the University of Iowa’s law school in Iowa City. Many economists tend “to see this as a really bad solution to problems of inadequate competitiveness,” Hovenkamp said.

In July, the House Ways and Means Committee passed legislation with a government plan that would be able to set fees at or slightly above discounted rates paid by the Medicare health plan for the elderly.

Negotiate Rates

A separate measure passed Aug. 1 by the House Energy and Commerce Committee requires a public plan to negotiate rates just as private insurers do. House Democratic leaders are working to meld different committee bills into one proposal.

Without authority to mandate lower fees, government plans may not attract enough customers to get the economic clout needed to negotiate better rates from hospitals and doctors. The Congressional Budget Office estimated that a public option would enroll 9 million to 12 million people, compared with about 160 million people covered by employer-provided insurance.

“If you are going to scale back the public option and say they can’t buy at Medicare rates and have to negotiate” government coverage “will have no advantage to other plans -- so why bother?” said Paul Ginsburg a health-care economist and president of the Washington-based Center for Studying Health System Change.

Supporters say a public plan would spend less on administration and advertising than private insurers, saving money that can be translated into lower premiums.

Low Costs

A government-run plan has “a built-in, low-cost structure” because it doesn’t have to make a profit, said David Cutler, an economist at Harvard University in Cambridge, Massachusetts. “It’s probably got very minimal market costs” because “it will instantly have name recognition.”

Obama is right when he says that health-insurance markets in many parts of the country are dominated by one or two providers, said Leemore Dafny, a health-care economist at Northwestern University’s Kellogg School of Management in Evanston, Illinois.

Among other factors, antitrust authorities permitted combinations such as UnitedHealth Group Inc.’s $8.2 billion purchase of PacifiCare Health Systems Inc. in 2005 and Anthem Inc.’s $19 billion acquisition of Wellpoint Health Networks Inc., forming WellPoint in 2004.

“Most Americans live in markets dominated by a small number of insurers,” Dafny said. Consolidation has created an industry that’s “not particularly innovative and has failed to deliver cost-effective care,” she said.

Little Competition

Alternatives to a government plan include taxing the value of employer-provided coverage to give consumers a bigger financial stake in the cost of insurance. Competition and lower premiums would be encouraged if employees bought insurance, instead of employers who now offer limited choices, Herzlinger said. “The reason we have so little choice of health-insurance packages is that you and I don’t buy them,” Herzlinger said.

Obama’s proposal to establish insurance exchanges, where consumers could choose among plans, may spark competition without a government-run alternative, said Martin Gaynor, an economist at Carnegie Mellon University in Pittsburgh.

“Maybe a whole bunch of firms would enter that exchange that are currently not active” in an area, Gaynor said.

If coverage becomes “more of an individual decision,” competition should follow, Dafny said.

When consumers have “more skin in the game,” Dafny said the U.S. “should get an explosion of offerings.”

To contact the reporter on this story: James Rowley in Washington at jarowley@bloomberg.net

Last Updated: September 5, 2009 00:01 EDT