Let me address these in order:
1. Will paying marginal cost put anyone out of business? I don’t think so. First of all, there are no required providers in this scheme, because there is no public health care system — only public insurance. So, if it becomes unprofitable, providers will exit the market, increasing the market power of the survivors, allowing them to raise prices (because, at the end of the day, someone has to provide the care). Even if there was an initial market shock, we would expect equilibrium to be reached in the long term. As a side benefit, one would expect that only the most efficient produces would be able to survive, increasing the overall efficiency of the market. Re: new drugs specifically, this system says nothing about patents, so presumably they would continue to remain a compelling incentive to produce new medications. No, I don’t think the current patent system is perfect in this regard, but I think a slight adjustment there is all that it would take to fix any problem that would arise under a national insurance scheme. Keep in mind also that while a private company theoretically has a fiduciary duty to haggle for the lowest achievable price for drugs, the government does not. In principle, the government could effectively subsidize new drug development simply by agreeing to give those drugs an advantage in price negotiation.
2. Will insurers be able to stay in business? Definitely. Respectfully, I think you’ve forgotten the whole business model of insurance: that people are risk averse, and are therefore willing to pay more in premiums than the expected cost of their care, in order to eliminate the possibility of extreme loss. This won’t change, so insurers will continue to be able to operate. Insurance is one of the most adaptable business models in the economy; it’s possible to insure just about anything, including the residual risk under a public insurance option. In theory, a competitive market would encourage insurers to offer premiums which asymptotically approach zero profit, but in practice, low premiums would mean that that capital could be more profitably invested elsewhere, insurers would leave the market, and the market would become less competitive until equilibrium is reached again.
3. What about overutilization? Frankly, I consider the problem of overutilization the primary motivation of this policy, and the thing I dislike most about the ACA. The ACA puts coverage requirements on all insurance plans, and requires everyone to buy them. The net effect is that everyone is insulated from the cost of their care. No one would ever have to pay more than X dollars out of pocket for any given type of care, and as a result, no one ever has any reason to second guess their doctor on the basis of cost. Public low-benefit insurance would enable portions of the population to be less insured (not because they can’t be insured necessarily, but because they do not want to be), and thus, relative to the ACA status quo, reduce the average incentive to over-utilize. Apart from the national insurance cornerstone of this policy, (an extreme solution which is, I feel, warranted by the national nature of the problem,) this argument tracks the standard conservative alternative to the ACA — high deductible/health savings plans. These combine high deductibles with health savings accounts in anticipation of having to pay the deductible eventually, with the same goal in mind: forcing individuals to bear the costs of their care, while still ensuring that they have access to the care that they need. The former is the key to reducing overutilization, and the primary failing in the ACA is that it lacks this factor.
