The media is making a lot of hay about the CBO conclusion that with its negotiated rates, the House’s public option will have premiums slightly higher than private insurance on the exchange.

That estimate of enrollment reflects CBO’s assessment that a public plan paying negotiated rates would attract a broad network of providers but would typically have premiums that are somewhat higher than the average premiums for the private plans in the exchanges. The rates the public plan pays to providers would, on average, probably be comparable to the rates paid by private insurers participating in the exchanges. The public plan would have lower administrative costs than those private plans but would probably engage in less management of utilization by its enrollees and attract a less healthy pool of enrollees. (The effects of that “adverse selection” on the public plan’s premiums would be only partially offset by the “risk adjustment” procedures that would apply to all plans operating in the exchanges.)

What this means is that the public option would be able to provide high quality, low hassle health insurance at a better unit cost. The public option would have a very large provider network, lower administrative overhead, very little paperwork for doctors and patients, and be much less of a headache to use.

The problem is that these great qualities would make the public option substantially more attractive to less healthy people.  People with medical problems have tended to be treated extremely poorly by private health insurance (imagine that!). They are also the individuals who are most likely to be diligent shoppers on the new exchange.

The public option would be one of the best health insurance providers on the new exchange (if not the only good one). As a result, it will attract the sicker customer base which has been screwed over by private insurance companies. This is called “adverse selection.” It would have slightly higher premiums, ironically, because it can provide health care at a lower cost. The public option’s problem is that it would be one of the only plans doing its job properly and not trying to get around the regulations at every turn.

This illustrates a serious, reform-crippling problem with the House’s bill. It has an insufficient “risk adjustment” procedure. The risk adjustment mechanism should be a re-insurance program that redistributes a large amount of money among the plans on the exchange based on the health of their different customer bases. Without a strong risk adjustment mechanism you are literally guaranteeing it will be impossible to get high-quality, low-hassle insurance on the new exchange.

I have explained the critical issue in more detail before. The problem is, if any insurance company tried to be socially responsible, it would soon be flooded with sick costumers tired of being treated badly. This would end up making “bad” insurance companies more profitable because their bad behavior will drive away their unprofitable, unhealthy customers. The result is a marketplace were it is financially impossible to run a social responsible insurance company. Unless the risk adjuster is dramatically strengthened (or a very robust public option that can afford to absorb a lot of adverse selection is enacted), I can promise you reform will create incentives that prevent you from getting quality health insurance.