What do prediction and financial markets have to say about the prospect of dropping the public option and replacing it with health care co-ops? Arin Dube has an answer (which is a follow-up to this post):

Public Option versus “Co-ops”: The Market Test, by Arin Dube : President Obama says he is serious about making sure we have a competitive alternative to the private health insurance companies to drive down costs. However, he is now apparently open to the idea of “health co-operatives” that will be regional purchasing pools operating independently of the federal government. How well will these co-ops achieve his stated goals? To assess this, we can start with his own words and those of his subordinates. Well, to be precise, how various investors reacted to these words.

Exhibit A

So as the public option’s condition went to critical, and “co-ops” started looking increasingly likely, how did investors in the top 4 private health insurance companies react? As exhibit B shows, champagne bottles were popped.

Exhibit A shows how investors in the Intrade prediction market reacted to signals from the Obama administration on Sunday August 16 that they are willing to ditch the public health insurance option. In the market’s assessment, the likelihood of a federally administered health plan passing fell from around 35% to around 20%, the biggest one-day drop since the prediction market started in June.

Exhibit B

On a day when the broader stock market took a hit (dropping 2.2% at the time of writing), these four companies with a combined market cap of $80 billion saw their prices rise an average of 3%. Actually, if you dot the i’s and cross the t’s in calculating “abnormal returns”** for these four companies, it comes to be 5.8%. All in all, statements by the Obama administration over the weekend helped investors of private health insurance markets make around $4.6 billion.

So, as the market’s assessed likelihood of the public option passing dropped by 15 percentage points, share prices rose by around 6 percentage. If you are willing to extrapolate based on this event, going from a public option to “co-ops” would be worth around 40% of the value of these companies, or around $32 billion. This is similar to the results from my previous analysis of how market reacted to announcements by members of the Senate Finance Committee.

President Obama may have harsh words for the insurance companies. But those are not the words investors in these companies are paying attention to. They are paying attention to whether President Obama will sign a bill with vague “co-ops” or demand a public option. And the reaction by these investors bodes poorly for “co-ops” fulfilling their role as a serious competitive alternative to private insurance companies.

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** Abnormal returns are calculated as [Raw Return] – beta * [Index Return]. Betas for AET, UNH, WLP and CI are 1.3, 1.14, 1.15 and 1.88 respectively (from Google Finance).

Arindrajit Dube is an economist at UC Berkeley Institute for Research on Labor and Employment who is joining the Department of Economics at the University of Massachusetts, Amherst. His work focuses on labor and health economics topics, as well as political economy.