What is the effect of government competition on the health care market?

I was recently asked to describe how the proposed government competition in the health care market (represented by the “public option” would affect health care costs. I wrote the following to illustrate that the issue is not a simple question of free market vs. government control.

Theoretically competition would encourage private insurers to reduce their profit margins (to spend more of their premiums on health care coverage), but you have to be careful to analyze why their profit margins are around 20%… and what mechanisms of competition you would introduce with a “public option”… Insurance companies try to assure those profits now by recission and cherrypicking customers to avoid those with highest risk and by preventing those who buy insurance independently from buying into group pools. (There’s also the issue of insurance companies getting huge discounts on medical bills from hospitals– read this for one account of how they game the system: http://www.alternet.org/healthwellness/134353/fainting_in_this_country_can_carry_a_$10,000_price_tag/ )

For example, the way the “public option” is set up in some of the bills right now, people who get insurance through their employer would not be able to choose it, and in fact many uninsured people wouldn’t be able to choose it either. Here’s a flowchart explaining who would be eligible: http://www.donkeylicious.com/2009/08/flowchart.html

The effects of the changes the insurance industry will be able to force into the bill may make it so that the only people eligible for the public option are generally “high risk” customers, while the mandate in the bill that everybody must buy insurance forces most of the uninsured with low risk (generally young people) to buy private insurance that they are unlikely to use fully. The effect of a public option that gets only the most expensive customers will be to create huge cost overruns on the public side and greater profits on the private side. Then the private guys can say “look! the government can’t run health care! see what we’ve been saying?!?!?!” when the reality is that the program was just set up to fail.

Another change in regulation that has been proposed by some is to allow people to buy insurance across state lines to get a better deal. This seems like it would increase competition, but consider: a company currently offering insurance in many states could then offer it only in states with the weakest consumer protection laws, so the policy may be cheaper, but there may be changes that affect the available quality.

Another element is that medical insurance companies are exempt from federal antitrust laws (Peter DiFazio is trying to change this, but not getting listened to.) Only this industry and professional baseball are exempted. This exemption exists despite evidence of real collusion between the companies to establish this 20% profit margin. This is another factor to consider when trying to analyze the effects of the “free market” in health care, because idealized free market models rely on competition, not collusion.

So some reforms may introduce competition, but you have to be careful to look at what the competitive mechanism is and what might undermine the effect. You have to analyze how the “free market” would be competitive or uncompetitive in this instance… whether it would actually be a free market or not, in effect. I would argue that health care is not a very free market, and that is the reason behind the 20% profit margins. Reforms that further cartelize the industry would not be effective, but reforms that introduce real meaningful competition might reduce that 20% figure and improve quality. But the proposed legislation doesn’t exactly address the real mechanisms of why it is uncompetitive, and the “public option” as figured, doesn’t do a very good job of competing on a “free market model”, because few people can actually choose it.

So while it may “seem” like a “free market” could manage this system most efficiently, you have to look at why the current system is so inefficient and decide whether it is “free” or not, and then look at proposed reforms to see what the actual effects will be. They cannot be generalized to “increasing regulation” as a single linear variable, and their effects will not be something as simple as “drives prices up.”