SYNOPSIS: The Republican medical insurance plan ignores medical reality.

In denouncing President Clinton's plan to extend Medicare coverage to prescription drugs, and in touting their own counterproposal, Republicans have rolled out the usual rhetoric. They excoriate the administration plan as a bureaucratic, "one size fits all" solution. They claim that their plan offers more choice.

And for once their claims are absolutely right. The Republican plan does offer more choice. Unfortunately, this is one of those cases in which more choice is actually bad for everyone. In fact, by trying to give people more choices the Republican plan would end up denying them any choice at all.

Where Democrats want to offer drug coverage directly to Medicare recipients, the Republicans propose to offer money to private insurance companies instead, to entice them into serving the senior market. But all indications are that this plan is a non-starter. Insurance companies themselves are very skeptical; there haven't been many cases in which an industry's own lobbyists tell Congress that they don't want a subsidy, but this is one of them. And an attempt by Nevada to put a similar plan into effect has been a complete dud -- not a single insurer licensed to operate in the state has shown any interest in offering coverage.

The reason is "adverse selection" -- a problem that afflicts many markets, but insurance markets in particular. Basically, adverse selection is the reason you shouldn't buy insurance from companies that say "no medical exam necessary": when insurance is sold to good and bad prospects at the same price, the bad risks drive out the good.

Why can't the elderly buy prescription drug insurance? Suppose an insurance company were to offer a prescription drug plan, with premiums high enough to cover the cost of insuring an average Medicare recipient. It turns out that annual spending on prescription drugs varies hugely among retirees -- depending on whether they have chronic conditions, and which ones. Healthy retirees, who know that their bills won't be that high, would be unwilling to buy insurance that costs enough to cover the bills of the average senior -- which means that the insurance plan would attract only those with above-average bills, meaning higher premiums, driving still more healthy people away, and so on until nobody is left. Insurance companies understand this logic very well -- and are therefore simply not interested in getting into the market in the first place.

The root of the problem is that private drug insurance could be offered at a reasonable price only if people had to commit to paying the necessary premiums before they knew whether they would need expensive drugs. Such policies cannot be offered if those who find out later that they don't require such drugs can choose to stop paying what turn out to be unnecessarily high premiums.

And while in principle one could write a contract that denies the insured the choice of opting out, just try to imagine the legal complications if a private company tried to force a healthy retiree to keep paying high premiums for decades on end, even though he turns out not to need the company's benefits. As a practical matter the only way to avoid this opt-out problem, to enforce the kind of till-death-do-us-part commitment needed to make drug insurance work, is to make the coverage part of a government program.

All of this is more or less textbook economics. So why are Republican leaders insisting on a plan that almost nobody familiar with the issue thinks will work?

Cynical politics no doubt plays an important role.

So does money; the insurance industry is by and large against the Republican plan, but the pharmaceutical industry is very anxious to avoid anything that might push down drug prices, and fears that the administration plan will do just that. But sincere fanaticism also enters the picture. Republican leaders in the House, in particular, are true believers in the miraculous powers of the free market -- they are in effect members of a sect that believes that markets will work even when the businessmen actually involved say they won't, and that government involvement is evil even where conventional analysis says it is necessary.

The Republican plan is, in short, an assertion of a faith that transcends mundane economic logic. But what's in it for us heathens?

Originally published in The New York Times, 7.26.00