Academic journal article Economic Inquiry

The Impact of a Public Option in the U.S. Health Insurance Market

Academic journal article Economic Inquiry

The Impact of a Public Option in the U.S. Health Insurance Market

Article excerpt


One of the most controversial issues in the recent debate over health care reform in the United States is whether the reform should include a "public option," that is, a nonprofit insurance plan managed by the federal government that would compete with the private, for-profit insurance plans. Advocates of the public option argue that a nonprofit insurance plan, with lower administrative costs and without profitability pressure, will not only provide a less expensive option to the general public, but will also discipline the private insurers because of the competition it brings to the market.

Opponents of the public option, on the other hand, warn that the public option may eventually drive out the private insurers and take over the whole insurance market. For instance, in its comments submitted to the U.S. Senate Finance Committee on June 10, 2009, the American Medical Association opposed the creation of the public option, stating that health services should be "provided through private markets, as they are currently," because "the introduction of a new public plan threatens to restrict patient choice by driving out private insurers, which currently provide coverage for nearly 70 percent of Americans," and that "the corresponding surge in public plan participation would likely lead to an explosion of costs that would need to be absorbed by taxpayers" (New York Times, June 10, 2009).

In this paper, we tackle this issue and estimate the potential impact of a public option in the U.S. health care system by estimating the crowd-out effect of private insurance from this market. To this aim, we start by developing a theoretical model in a stochastic environment, in which a continuum of heterogeneous consumers, each facing unknown medical expenditures, but differing in their expectations of these expenditures, have to choose between two plans. One plan is offered by a profit-maximizing private insurance company; the other, by a public insurer that aims to maximize social welfare while not sustaining a budget deficit. We then estimate and calibrate the model and provide an empirical characterization of the Nash equilibrium of the market structure.

To examine the empirical characteristics of market equilibrium as implied by the model, we need to obtain a realistic calibration of the underlying distribution of the expected medical expenditures for the U.S. consumers. This is because when purchasing medical insurance, consumers are unable to observe the actual medical expenditures in the future. Rather, they have to make their decisions based on the probabilistic distributions of the actual medical expenses that they may incur over the following year. Therefore, they face uncertainty when making purchasing decisions, even with the private knowledge of their own health status.

Most of the existing studies in the literature, however, have been concentrated on analyzing a group of consumers' actual medical expenditures, for instance, by regressing the actual expenditures on various observable characteristics of the consumers in a given sample, such as age, gender, and income. Such a methodology can generate a model-based prediction of the actual expenses, that is, a fixed number for each individual, conditional on the observed consumer characteristics. However, it is unable to capture the uncertainty or the probabilistic distribution that each individual faces when making purchasing decisions, and can only provide a group of different predicted values for a given set of consumers, rather than the distribution of a continuum of heterogeneous "types" or expectations of medical expenditures for the whole U.S. population. We thus decide to take a more structural approach and estimate a Bayesian hierarchical model of conjugate likelihood distribution of the expected medical expenditures. Then, we numerically solve the model and compute the market equilibrium, employing standard risk-preference parameter values and the estimated distribution of medical expenditures. …

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