The man who watered down the public option explains what government economists got wrong.

How to fix health policy.
Nov. 19 2009 1:02 PM

Mr. Level Playing Field

Len Nichols explains why his "level playing field" is misunderstood by the Congressional Budget Office.

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The adverse-selection problem hadn't even been mentioned in Nichols' and Bertko's original paper. It had, however, been discussed by Princeton sociologist and Hillarycare veteran Paul Starr in a rather prescient June essay for the American Prospect ("Perils of the Public Plan"):

Here's the delicate political problem: Depending on the rules, the entire system could tip one way or the other. Unconstrained, the public plan could drive private insurers out of business, setting off a political backlash not just from the industry but from much of the public. Over-constrained, the public plan could go into a death spiral itself as it becomes a dumping ground for high-risk enrollees, its rates rise, and it loses its appeal to the public at large. Creating a fair system of public-private competition—giving the public plan just enough power to offset its likely higher risks—wouldn't be easy even if it were up to neutral experts, which it isn't.

Starr elaborated in an August essay for the American Prospect ("Sacrificing the Public Option"):

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Private insurers have spent decades perfecting the art of attracting the well and avoiding the sick. As the annual open enrollment approaches, for example, insurers will strive to re-enroll their current healthy low-cost members, while letting the sicker ones migrate to other plans. The public option, however, would likely refrain from using practices of this kind, and its costs would be correspondingly higher. Instead of being outcompeted, the private insurers could use the public plan as a dumping ground for the sick.

Some provisions in reform legislation attempt to mitigate this risk. The most important of these calls for "risk adjusting" payments by the exchanges to the plans—that is, providing a bonus to plans that enroll a sicker population and paying proportionately less to plans that enroll a healthier group. But it would be a mistake to think that such methods can completely avert the danger that the public plan will experience higher costs. As a result, just to break even, the public plan might require higher premiums than private insurers charge.

When I mentioned Starr's pieces to Nichols, he said he hadn't read them. But he's well familiar with utilization management, and he thinks it's a red herring. Yes, he said, of course private health insurers engage in it—and so would the level-playing-field public option. A level playing field means that if Aetna is cherry-picking and lemon-dropping, Uncle Sam must do so, too. CBO and the Centers for Medicare and Medicaid Services, Nichols told me, "are presuming public option managers will be passive." But they won't be.

Vigorous utilization management, Nichols explained, is already standard practice in the public plans that more than 30 states currently offer to state employees as an alternative to private health insurance. But what about people with chronic medical conditions, I asked. "Most people who have the most serious chronic conditions already have coverage," Nichols answered. And, anyway, Nichols said, by requiring guaranteed issue (i.e., insurers must take all comers), health reform will give private insurers a financial interest in their customers' continued good health that they didn't have before. The same would be true for the public option.

OK, I said. Then why have a public option at all?

Nichols' answer surprised me. In many places, he said, it isn't necessary. In Seattle, in Denver, and in Northern California, he said, there's already a lot of aggressive competition among health insurers.

But in other, typically more rural places, he said, it is necessary—in Arkansas, for instance, where Nichols is from, and North Dakota and Maine—because these places are much more likely to be dominated by a single insurer (typically "the Blues"—i.e., BlueCross BlueShield, which, since their origins in the 1930s as community-minded nonprofits, have largely evolved into aggressive for-profit companies). In Little Rock, Ark., Nichols told the Senate commerce committee in July, BlueCross BlueShield has a 75 percent market share. The Blues maintain their dominance, especially in the small-group market, by paying doctors "at very high levels," Nichols testified, driving up prices so high that potential competitors like Aetna or Cigna can't sign them up.

The head-splitting irony is that these rural places are the very ones most opposed to health reform generally and a public option in particular. Sen. Blanche Lincoln, D-Ark.; Sen. Olympia Snowe, R-Me.; and Sen. Kent Conrad, D-N.D., all voted against the public option in the Senate finance committee. The political resistance in such places to the public option has turned Nichols against Reid's opt-out provision. Why offer an opt-out, Nichols says, when the likeliest places to opt out are the ones that need the public option the most? Instead, Nichols favors Snowe's trigger. If health reform brings in enough private competition to get the rural monopolists to clean up their act, he says, mission accomplished. If not, their continued dominance will trigger competition.