Public Option Compromise: Size Matters

Robert Reich has an interesting post today on the Senate public option compromise. First he reminds readers that the compromise includes (1) an expansion of Medicare for certain individuals without employer coverage and 55-64 years of age and (2) for younger individuals a system of private plans modeled on that available for federal employees (details in this NY Times article). Then Reich writes that

we still end up with a system that’s based on private insurers that have no incentive whatsoever to control their costs or the costs of pharmaceutical companies and medical providers. If you think the federal employee benefit plan is an answer to this, think again. Its premiums increased nearly 9 percent this year. And if you think an expanded Medicare is the answer, you’re smoking medical marijuana. The Senate bill allows an independent commission to hold back Medicare costs only if Medicare spending is rising faster than total health spending. So if health spending is soaring because private insurers have no incentive to control it, we’re all out of luck. Medicare explodes as well.

I agree with all that. However, Reich then goes on to explain that private insurers can’t control costs because they’re too consolidated. This actually doesn’t make much sense. Insurers, while apparently great fun to beat up on, are not the big problem. Providers are.

Though it is true that insurers with higher market power can charge higher premiums, they also obtain lower prices from providers. The optimal balance of power that results in the lowest premiums is not one in which insurers are weakest. In fact, insurers need a certain level of market power just to offset that of providers.

As I’ve written before, the vast majority of money flowing through private insurers ends up in the hands of providers. If one wants to address the health care cost problem one should follow the money to hospitals and doctors–to the prices they charge and the volume of ineffective services they provide. It is by no means certain that increased competition among insurers leads to lower prices.

That’s not to say insurers can’t play an important role. They can. The solution to taming health care costs is to provide incentives that will encourage insurers to pay providers differently, to pay for efficiency and quality, not volume. It will take reasonably powerful insurers to impose such a system on providers. The first type of insurer likely to do so is the big public one, Medicare. That there is any hope of success in this is due to the power Medicare wields from its size, which will be even larger (albeit by only a little) under the new compromise (hence the provider backlash).

To the extent that private plans can follow Medicare’s lead will be determined in large part by their market power. Blindly weakening insurers may throw the baby out with the bathwater. Of course, we haven’t even begun to fill the tub.

Later: Ezra Klein expresses similar ideas in a must read post today.

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