The Consequences of a Public Option in Healthcare: Evidence from Medicare Prescription Drug Markets

Publication Type

Working Paper

Publication Date



Policy makers in the US have debated the merits of including a government sponsored “public option” as part of a healthcare reform package. Alongside a menu of privately sponsored healthcare plans, the government would offer a standard plan with premiums set at cost. The government’s ability to negotiate favorable prices with healthcare providers and lack of profit taking could drive the down profits of private healthcare plans and perhaps crowd out private competition. The existing Medicare Part D prescription drug market does not have a public option, but otherwise resembles the proposed healthcare reforms. In this paper, we use data from the 2006-2010 Part D market to estimate a discrete choice demand system and supply side model for Part D plans. Using our estimates of healthcare plan markups, we compute outcomes in counterfactual marketplaces that include a public option. We design the counterfactual public option to match the plan proposed by legislators in the 2009 “Medicare Prescription Drug Coverage Improvement Act.” The legislation mandates that the government plan have a basic benefit structure corresponding to the minimum mandated coverage levels, that the plan can negotiate discounts and rebates with drug manufacturers, and that it set premiums equal to the cost of serving an enrollee. Our demand estimates have the expected signs on key product characteristics, such as premiums, drug formulary comprehensiveness, deductibles, and copay/coinsurance generosity. Our counterfactual indicates the basic government plan would be one of the top 5 plans, but it does not significantly crowd-out the market share of private plans. The government plan captures a 5.8% market share of all plans. The intuition for why a government plan only captures a modest market share is that it is competing in a differentiated products market against about 50 private plans. Private plans that differ with respect to several key plan characteristics do not see their residual demand fall to zero. The competitive response of private plans is to concede market share to the government plan by actually raising premiums on basic plans that are similar to the government plan, while competing vigorously and lowering premiums on its more generous plans. Overall, private plan profits decline by an average of 4.4%, while consumer surplus increases negligibly. The cost savings, from reduced profits, are instead realized by tax payers as lower subsidy payments to plans. Since it may the case that the government is able to negotiate more favorable terms with drug manufacturers, we conduct a sensitivity analysis with regards to the government plan’s cost of serving enrollees(results pending). (The counterfactual results are preliminary and only consider the South Carolina market. The results for the whole nation are pending. There are cross-market (state boundary) externalities with regards to the mechanism for how plan premiums are subsidized that we will account for in future work. We also will consider a model with forward-looking consumers to accommodate switching costs. This will enable us to assess the importance of dynamics in consumer behavior, and compare the counterfactual results under a dynamic and static model.)


Political Science | Politics and Social Change | Public Affairs

Research Areas


Creative Commons License

Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License
This work is licensed under a Creative Commons Attribution-Noncommercial-No Derivative Works 4.0 License.

Additional URL


This document is currently not available here.