The Obama administration spent the early part of this week seeking to assuage concerns that it was backing away from supporting a “public option,” a health insurance plan sponsored by the federal government that would compete with private plans in offering healthcare insurance through insurance exchanges in each state.

The public option has become the most contentious issue in the debate over healthcare reform. Opponents claim that a public option would undermine the market for private insurance, mainly because it would not incur the expenses of marketing and having to negotiate reimbursement rates with a network of providers, thereby enabling it to charge lower insurance premiums than private plans. In my view, it is not a foregone conclusion that a public plan would necessarily have an unfair competitive advantage in attracting beneficiaries. As some observers have pointed out, it is possible that a public plan would attract a disproportionate number of very sick beneficiaries, thereby saddling it with higher medical costs and possibly forcing it to charge higher insurance premiums than private plans, particularly if risk adjustments based on beneficiaries’ health status do not fully cover the higher medical costs.

Nevertheless, while a public plan would not necessarily pose such a dire competitive threat to private insurance plans as its opponents claim, given the difficulty of explaining the complexities of healthcare reform, opponents have been successful in simplifying the issue of healthcare reform as a further intrusion of the federal government into the practice of medicine. Therefore, to move the discussion beyond the role the federal government would play in offering a new health insurance plan, the Obama administration sought to downplay the public option.

This move angered supporters of the public option, who believe that, without the competitive pressures of a public plan, private insurers will not be forced to rein in spending growth. But the experience of private plans in the Medicare Part D drug benefit demonstrates that, even in the absence of a public option, competition among private plans can serve to drive down costs.

As an alternative to a public option, there has been some support for facilitating the creation of non-profit healthcare cooperatives that would compete with private plans. In fact, there are successful models for such a proposal, such as Seattle-based Group Health Cooperative, which is known for providing cost-effective, high-quality care. The problem is that such examples are relatively rare, and establishing cooperative from scratch takes time, with no guarantees that a new cooperative will succeed in attracting a critical mass of beneficiaries or be able to negotiate competitive reimbursement rates with local providers. Competition in some local insurance markets, particularly in rural areas, is currently often limited, with one plan often holding a dominant market position. Because the lack of insurance market competition is likely rooted, at least in part, in the relative scarcity of healthcare providers in these areas, attempting to foster competition through insurance market reforms may end up having little or no impact. In any case, some prominent Republicans have already expressed their opposition to cooperatives, too, so abandoning the public option in favor of healthcare cooperatives might not be the recipe need to attract Republican support.

The impasse appears to have left the Obama administration wondering if there is any formula for reform that leading Senate Republicans would support. There is now talk of splitting healthcare reform legislation into two bills, one of which, by using the reconciliation process (see Who is Alan Frumin post dated August 7), could pass the Senate with the votes of just 51 Democrats. This bill would include the new spending measures, such as Medicaid expansion and subsidies for health insurance premiums of low income beneficiaries, as well as the financing of these measures, and possibly could include the public option. The second bill, which would need to pass the Senate with 60 votes to avoid a filibuster, would include reforms to the market for private healthcare insurance. Of course, the Obama administration is still hoping that Senator Baucus can forge some kind of compromise in the Senate Finance Committee that attracts Republican support, but they are preparing a plan to push through reform legislation in the event a compromise fails to materialize.