Lack of competition in the medical industry is a real challenge for health care reformers. The question is whether a government-run insurance plan is the best way to attack the problem.

In the end, no other alternative may work. But creating a public competitor to private companies has not been the country's usual response to uncompetitive markets. The United States has typically responded with very different tools -- antitrust enforcement or laws targeting specific unfair practices. Given the fervor that the idea provokes, a public insurance plan might win broader acceptance if Americans believe that Washington has first exhausted more-conventional means for opening clogged medical markets.

The entire health care system would benefit from additional competition. The American Medical Association reported recently that insurance markets lack robust competition in more than 90 percent of metropolitan areas; in 16 states one insurer writes at least half the policies. Similarly, a Medicare advisory panel calculated that nearly three-fifths of hospitals operate in markets with little competitive pressure.

In theory, these dual trends could offset each other. Insurers might use their dominant positions to leverage better rates for patients from providers, who could otherwise inflate prices because they are also sheltered from competitors. That's the scenario in which Tokyo is spared because Godzilla and Rodan are too busy mauling each other.

In some places that outcome may occur. But economist Len Nichols, health care director for the centrist New America Foundation, says that insurers and providers in concentrated markets commonly rampage together. In those places, he says, locally dominant insurers often pay providers excessive reimbursement rates to discourage them from participating in rival insurance plans. That dissuades other insurers from entering the market, which, in turn, frees the leading insurer to raise its premiums to cover the inflated reimbursements. "The only people who lose in that," Nichols says drily, "are the patients." In other markets, insurers accuse dominant hospitals of demanding exorbitant rates.

These dynamics can bloat costs. Although many factors influence prices, two 2008 studies by Northwestern University management professor Leemore Dafny found that consumers generally pay more for health insurance in very concentrated markets. The Medicare advisory group, looking at non-elderly patients, found that hospitals in less competitive markets generated profit margins three times greater than those exposed to more competition.

Each of the pending health care bills would require most Americans to buy insurance. That makes these questions more urgent. As Nichols notes, insurers in uncompetitive markets could charge excessive premiums to those new customers and unfairly blame the sweeping reforms for the high fees.

The bills in Congress already contain some good ideas for spurring competition. All would allow the uninsured to buy coverage from "exchanges," marketplaces that enable people to easily compare competing plans. Paul Ginsburg, president of the nonpartisan Center for Studying Health System Change, says that such direct access to consumers could encourage new firms to enter uncompetitive markets because it reduces the cost of finding customers. "The exchange could be a very powerful device to increase competitiveness," he says.

So could a proposal in the bill from Senate Finance Committee Chairman Max Baucus, D-Mont. Today, insurance generally can't be sold across state lines. Baucus would permit states to jointly allow insurance plans sold in one state to be offered in the other. This differs from the Republican proposal to permit unlimited interstate insurance sales. The GOP approach would allow any policy sold anywhere to be sold everywhere, and effectively permit the state with the weakest regulation to write the rules for the 49 others. The Baucus variation would allow states to open their markets only to states with comparable consumer protections while simultaneously expanding consumer choice.

Providers operating without much competition would also face pressure to improve efficiency and cut costs from provisions in the bills that tie payments to results, not volume. Long-term change could likewise come from repealing the 1945 law exempting insurance companies from federal antitrust laws. Senate Judiciary Committee Chairman Patrick Leahy, D-Vt., recently proposed that step.

If reform's goal is to increase competition, rather than expand government, it makes sense to first pursue such approaches before creating a public competitor to private insurers. That's an argument for including a "trigger" that would launch a public insurance alternative only if private coverage remains too costly over time. Initially, Democrats may need to focus more on promoting healthy competition than on creating a public competitor.

This article appeared in the Saturday, September 26, 2009 edition of National Journal.

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