After decades of teaching, I view everything around me as a final exam and assign it letter grades.

Naturally, I graded President Barack Obama’s speech as well. The overall grade is A–, a highly respectable grade at Princeton, although there is variation around this overall average for the different themes in the speech.

The elegance and force of the delivery deserved a clear A, and one slouching toward an A+. I do not grade it A+ mainly because our Dean frowns at throwing around A-plusses lightly.

The president does, however, deserve a clear A+ for reminding Americans so clearly and forcefully of the moral dimension of health reform, assisted in that task by the late Senator Ted Kennedy’s eloquent farewell letter. One may disagree with these two gentlemen’s policies, but one should not ever doubt their compassion for this country’s less fortunate people. Americans never cease to remind the rest of the world that “Americans are the most generous people on earth.” The president reminded us that it would be nice if we actually owned up to that boilerplate in our own health care system.

Grade On The Public Plan

I had to agonize over the proper grade on the section dealing with the public health plan. As I understood that section of the speech, President Obama told the progressive wing of the Democratic party: “You certainly have a persuasive case in pushing for a public plan, a line of reasoning I share, but let’s face it folks: it ain’t gonna happen, nor is it the sine qua non of what we are trying to achieve with this health reform.”

My colleagues in the Political Science Department probably would score it as a solid A, because it may well have been politically skillful. Perhaps it will suffice to soothe the sentiments of the progressive Left.

As an economist, however, I have some trouble buying the president’s argument that a new public plan, added to the existing large number of private insurance vehicles, would inject more competition into the market for health insurance and that more competition in that market would help lower the cost of health care.

Let us note at the outset that the huge profits many critics of the private insurance industry imagine in their railing against the industry actually are not that huge. Fortune magazine lists “Insurance and Managed Care” at number 35 among the 50 most profitably industries in 2008, with an average profit margin (net after-tax profits as a percentage of revenue) of 2.2%. I find that margin on the low side. In normal times, the margin ranges between 3% and 5%. Even so, lowering that margin some through more competition would not yield much of a harvest in cost control.

To be sure, if a new public plan simply piggybacked on Medicare payment rates, it might help lower health spending — I say, “might” — other things being equal. There is market power in monopsony (the economist’s word for a single buyer), at least insofar as prices are concerned.

But as the sorry role of the sustainable growth rate (SGR) mechanism for physician payments under Medicare shows, without better control over the volume of care paid for, the ability to control prices has its limits, too. And if members of Congress believe that a new public plan would experiment with smart ways to control that volume so as to increase the value received for the dollar, one may ask why Congress has not allowed the already existing public plan, Medicare, to show the way. Why wait to delegate the whole task to an as yet nonexistent new public plan?

But what if the new public plan also had to negotiate over payments with providers, like any other insurance plan — to create the proverbial “level playing field”?

Here it must be remembered that the U.S. market for health care services is rife with a system of price discrimination under which the prices insurers (and individuals) pay hospitals and physicians depend solely on the relative bargaining strength of the negotiating parties. So I try to imagine now how having one more insurance carrier in a given market area, with each insurer now claiming a smaller market share of patients whom they could funnel to a particular provider, will enable each of them or at least the new plan alone to get lower prices from the providers of health care. I have trouble imagining it.

My theory is that the more insurers there are in a given market, the smaller will be each insurer’s market share, and the easier it will be for providers — especially those consolidated into large medical group practices or hospital systems — simply to blow off any insurers seeking large discounts off charges. In plainer English, the larger the number of insurers, the more each of them will morph into a mouse that roars.

It is also the reason why I am also not persuaded of the idea that the smallish regional cooperatives now being discussed in the Senate will do anything for cost control. These co-ops may possibly be a good political fig leaf in the current context, but they are unlikely to do anything to control U.S. health care spending. They would be likely to be not even mice that roared, but baby mice that squealed.

Speaking of relative bargaining power in the market for health care, one should note that even large insurers with a large market share in a market area might not have all that much bargaining power. I recall the bitter negotiations over payments between WellPoint and Sutter Health in California around the year 2000, in which WellPoint ultimately was brought to heel because patients and their employers sided with their doctors, who were affiliated with Sutter. Could WellPoint really hope to sell health insurance in Northern California without having Sutter Health (or Catholic Healthcare West, for that matter) in its network?

Similarly, although Blue Cross and Blue Shield of Massachusetts is a large player in that market area, it faces an equally large and powerful player in HealthPartners. Massachusetts is known for its high health spending — among the highest in the nation. Can one sell health insurance in Boston without HealthPartners in the network?

Finally, as a bit of a digression, while we’re on the subject of private insurance and cost control, the opponents of a public health plan frequently argue that such a plan would “underpay” hospitals and doctors, forcing the latter to recover the shortfall from private insurers through a cost shift estimated by Milliman Inc. to be around $90 billion a year.

If that is true, however, then one may ask the following question: If the private plans cannot resist increased prices as a result of this particular cost shift, how then can they resists any price increases justified to them by any cost, whatever its origin? How, for example, could they resist picking up the tab for the so-called medical arms race by which hospitals compete? I find this an intriguing question and invite comments thereon.

Now, with all that having been said, I would grade the section of the president’s speech dealing with the public health plan a B– or C+ on the economics of the issue, but I am open to persuasion by a second grader from the Political Science Department that it should be assigned a solid A. As is our wont in the academy, we’d probably settle on an A–.

I would more easily accede to a solid A if President Obama had said that the major attraction of a public plan might not even be its alleged ability to control costs but, instead, that it can offer those Americans who crave it a stable, permanent, and easily portable health insurance product. A challenge for the private insurance industry in the half-decade ahead will be to provide Americans with that stability and permanence in the nongroup health insurance market.

Grades On Cost And Financing

The president gets high marks for clarity in telling us roughly how much he is willing to spend on health reform ($900 billion or so over the next decade) and that he intends to finance it fully. So now we know that.

I am stunned, however, that he missed the opportunity — or voluntary shied away from it — to remind Americans that in 2003 President George W. Bush and his then Republican Congress passed a huge new health care entitlement without giving a moment’s thought on how to finance it: the Medicare Modernization Act of 2003 (MMA).

Current projections are that MMA will add $1 trillion to the federal deficit during the next decade (2010–19) for drugs alone, and close to $1.2 trillion if the president does not succeed in trying to harvest the roughly $170 billion or so that Medicare Advantage (private managed care) plans will receive in the form of a subsidy over and above what beneficiaries in these plans would have cost taxpayers had they stayed in traditional Medicare.

It’s nice to be a nice guy in a speech of this sort, but I just have to dock the president a few points of his grade on this section for failing to exploit this splendid opportunity.

I cannot give the president a good grade, either, for clarity on how exactly he proposes to finance the proposed $900 billion. Can it really be done just by redirecting funds already flowing from government into health care now? Is that clinically feasible? Is it even vaguely politically feasible? What would it imply for cuts to projected Medicare spending? Are added taxes for high income earners off the table now?

Similarly, many Americans with family incomes of, say, $60,000 to $80,000 must have come away from the speech wondering whether they have anything at all to gain from the proposed health reform. What in the ways of subsidies could be granted American families for $900 billion over the next 10 years?

Once again, my friends in the Political Science Department might lecture me that the clarity economists seek in such matters is out of place in the political arena — that the president went as far as is politically savvy in this case. After all, complete lack of clarity all along on the cost of our two wars abroad made them much more politically palatable.

I would defer to my colleagues in negotiating a grade. As an economist, however, I would find it hard to grade the entire section on cost and financing as more than a B–, going into the negotiation, and even that only in a fit of generosity in grading.

Grade On Malpractice Reform

Finally, I would give the president an A for at least waving an olive branch towards those Americans who believe that malpractice reform by itself would be a major instrument of cost control in our health system. It would be helpful, for starters, to experiment vigorously with alternative forms of dispute resolution. I find mere caps of awards for pain and suffering too much of a meat-ax approach.

We know that malpractice premiums are only a small percentage of total health spending. It is often alleged, however, that possibly as much as 15% of total personal health spending in the United States may originate in defensive medicine. Could we perhaps harvest that money through malpractice reform?

 Perhaps. I am not aware of any robust empirical evidence for the claim that malpractice insurance is a major cost driver. Instead, I am reminded of a tongue-in-cheek talk I gave some 15 years ago or so to the American Medical Association, counseling the doctors assembled there by all means to lament the malpractice problem loudly, but not so loud that God might hear them and do away with the phenomenon. Would they then cheer, I asked them, to see their revenue decline by 15 percent? I recall many blank stares.

If I had to bet, I would wager that malpractice reform might yield some small cost savings, but not a sizable amount. Which is not to say, of course, that there are not other, nonmonetary reasons to replace the tort system in health care, as in many other forums of economic activity, with alternative forms of dispute resolution. The health policy research community has come forth with such proposals for over three decades now.