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Obamacare's Public Option Is No Longer Defensible

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Since I last wrote about it, Aetna’s withdrawal from the Obamacare exchanges has ginned up even more drama. 

Jeff Young and Jonathan Cohn of the Huffington Post published a letter in which Aetna told the Justice Department that it would reduce its exchange participation unless Justice allowed the merger with Humana to go through. This has naturally triggered a firestorm of accusations about “extortion”  and renewed calls for a public option that can protect people against the threat of insurance-less insurance exchanges.

Could a "public option" fix the problems on the exchanges? More precisely, the question is: What problem would a public option solve?

Way back in 2010, when the idea of a government-run nonprofit health insurance option was hotly debated, supporters gave three answers to that question:

  • A public option does not need profits, so it can sell insurance cheaper than an insurer that wants to mark up coverage for profit margin.
  • A public option will have lower administrative costs than a private insurer.
  • A public option can force providers to accept below-market reimbursements for their services.

The first argument turns out to be irrelevant, because with the exception of Medicaid managed-care plans, few insurers seem to be taking sizeable profits out of the exchanges. Indeed, since the public option was conceived as self-funding (meaning it covers its costs out of premiums, with no subsidies), there’s a high risk that the public option would prove as doomed as the co-ops, because it would have neither the experience in caseload management to make money nor the other lines of business to subsidize losses on the exchanges.

However, supporters argue that a public option would have competitive advantages that would allow it to break even where others are currently losing money. One of those competitive advantages is lower administrative overhead -- in theory, at least. I’ve already outlined, however, why I’m skeptical of this: While Medicare does have lower administrative costs than insurers, a lot of that benefit lies either in outsourcing normal administrative costs to other parts of the government (where they are still costly, but not on Medicare’s books) or in not doing things that insurers have to do, like all the boring customer service and billing that comes with selling to the public, rather than enrolling every citizen over the age of 65.

And then there are provider prices. Medicare pays providers less than private insurers. The idea is that the public option could pay more than Medicare, but less than private insurers (say, Medicare rates plus 5 to 10 percent), and thereby offer a cheaper product than private insurance.

In some sense, it’s hard to argue with this: A public option could do this. In theory. But … if this idea is so clever, why haven’t insurers done it? Probably because they will have difficulty finding enough providers who will accept those reimbursements.

Now, the public option could, with legal support, perhaps force providers to take those rates -- say “If you don’t accept public option patients, you can’t see Medicare patients either.” The problem is that if you try that, all the groups who would be affected: hospitals, doctors, auxiliary service providers, health-care workers’ unions and so forth -- will descend upon their legislators with the white-hot fury of a thousand suns. These folks are well organized. They are extremely mediagenic. No lawmaker wants to be seen cutting the salaries of nurses in the neonatal intensive care unit.

But let’s assume that somehow the government manages to get past this massive political obstacle and force a pay cut on our nation’s health-care providers. It’s not clear to me that the public insurer would be able to make money even then; given the risks of gaming and adverse selection, there may be no price at which insurance can be sold to the middle class on the exchanges. But even assuming that it works, what happens to those providers?

At the moment, their cost structure is covered by a mix of public insurance paying lower reimbursement rates and private insurance offering higher reimbursements. Hospitals and medical practices manage that balance quite carefully to ensure that they can cover salaries and overhead. If the individual market is taken over by a public insurer paying less than they’re currently getting, how many hospitals go into the red? How many doctors decide that they can no longer afford to take any public insurance?

In short, while a public option might appear to fix one problem, that's a mirage: The "problem" it would fix does not exist, and worse yet, it would create new problems. 

Health care regulation often has this problem, which is why much-heralded reforms so often fail to live up to their promise. Keeping costs down turns into a giant game of whack-a-mole : You knock them down in one area, and they just show up somewhere else. Or they show up as politically toxic shortages that have to be fixed by … spending more money.

There are two unavoidable realities of making the American health-care system less costly: Americans must use less care, and our nation’s legion of well-paying, stable jobs in the health-care sector need to be both less numerous and less well paid. What no one can figure out is how to generate the political will to make this happen. The public option doesn’t fix that political problem.

The public option was best sold as a way to keep insurers from taking excess profits off of a customer base that was required to buy their product. But as it turns out, that’s the exact opposite of the problem we actually have. Which makes it a little mystifying that the public option is still seen as the solution. Somehow in supporters' minds, it has become a harmless homeopathic remedy that will cure any disease that ails you. In medicine, when we see such claims, most of us know that we’re looking at a useless quack nostrum. In policy, we should be similarly skeptical of miracle cures.

  1. This is orthogonal to the actual topic of this column, but for those who are going to request me to weigh in, my take is this: Justice asked Aetna for a letter outlining how the Humana merger decision might affect its participation in the exchanges. Aetna responded. The uncharitable view is that Justice basically phished that letter as a weapon against the insurer, but I think even the neutral reading is that Aetna was asked a question and responded to that question. This hardly qualifies as “extortion” unless you think that Aetna has a moral obligation to sell money-losing insurance policies, and was illegitimately threatening to do something it has no right to do.

  2. Full disclosure: The author of this link in my husband, who in addition to being handsome and charming, is a fine writer and very smart about health-care policy.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor responsible for this story:
Philip Gray at philipgray@bloomberg.net