Nate Silver defends the public option

Okay, before I form an opinion of Nate’s post, I just want to run this past Mark and the other libertarians ’round here because this is similar, if more detailed, to arguments I’ve made:

I’m a big believer in the profit motive in 99 percent of all cases. If the government decided to open a non-profit hamburger stand, I doubt that it would compete successfully against Five Guys. If it tried to open a non-profit airline, I doubt that it could offer the same value as JetBlue. Insert joke about General Motors and/or the Post Office here. The point is, I think the profit motive is generally well worth it in terms of the incentives it creates to cut costs, develop new products, improve customer service, and so forth.

But health insurance is not like those things.

Insurance exists because of the decreasing marginal utility of income: most people would rather have a 100% chance of paying $300 a month than a 1% chance of paying $30,000 a month. In fact, our hypothetical customer — let’s call him Frederick, after George F. Will’s middle name — might very well accept a 100% chance of paying $400 a month rather than take 1% chance of having to pay $30,000, which he might not be able to afford. This is true even though Frederick will lose $100 on this deal in an average month.

There’s nothing wrong with this arrangement — the customer has improved his marginal utility and the insurance company has made $100. It’s a win-win.

The thing is, though, that the insurer hasn’t had to work particularly hard for his $100. He hasn’t had to figure out how to cook up tastier fries or save you a few bucks off the cost of your next flight to Orlando. All he has to do is to have a bunch of money pooled together, such that he has a different marginal utility curve than you do. He has the luxury to accept the risk of unlikely outcomes, particularly if he can hedge his position by making the same deal with other customers, most of whom won’t wind up requiring an angioplasty or cataract surgery, even if Frederick does.

Now, what’s supposed to happen in the free market is that another company will come in and offer Frederick a better deal: they’ll offer him the same coverage for $350 a month, accepting a smaller profit, and Frederick will happily take the deal. There are at least a couple of reasons, however, why this may not be happening in the insurance industry. The first is that Frederick might not realize he’s paying $400 every month for insurance. That’s because if he’s like the majority of Americans, he’s getting his insurance through his work, and except when the HR lady gave him a shiny brochure on his first day at the office, he’s probably never thought very much about what this insurance is costing him in terms of foregone salary. This is particularly so because health insurance benefits, unlike other types of income, aren’t taxed, and so Fredrick is less cognizant of them if show up on his paycheck at all. Not only, then, is the free market maxim of perfect information violated, but it’s violated in such a way that creates artificial profits for the insurance industry: the government is effectively subsidizing every dollar that Frederick’s company is willing to spend on his insurance benefit.

The profits the insurance industry is making, of course — profits artificially boosted by an enormous backdoor tax subsidy — don’t seem to be buying the customer much of anything in terms of improved service or cost savings. On the contrary, health care costs are rising by as much as 9-10 percent per year, without any concomitant increase in the level of service. If JetBlue were raising the cost of its fares by 10 percent per year, they’d be out of business….

So this makes sense to me, but I’m sure others will disagree.  Why?  What’s wrong with this picture?  And what’s the alternative, since I think people from many ideological corners agree that this is a problem both moral and economical.