Economist, Alex Tabarrok of George Mason University has this to say about why the public option is desirable, maybe necessary to avoid sharp increases in health insurance premiums.
"The major proposals would require insurance companies to take all customers regardless of pre-existing conditions, offer guaranteed renewability and no dropping of coverage for the ill, impose no annual or lifetime caps, and offer coverage of preventative care with no-cost share, among other requirements. Finally, if insurance companies must take all customers regardless of pre-existing conditions it is obvious that sooner or later and probably sooner the government will require that everyone purchase health insurance.
In short, insurance reform will mean that everyone will be required to buy a product that will be tightly regulated and more homogeneous. Both of these factors will increase the market power of insurance firms. Since escape via non-purchase will no longer be a potential response to higher prices, mandatory purchase will reduce the elasticity of demand giving firms an incentive to increase prices. Moreover, in oligopolistic markets, a more homogeneous product can increase the ability of firms to collude.
I believe that health insurance reform will increase the market power of insurance firms and drive up prices. In this scenario, the public option at least has a raison d'etre, although whether it actually fulfills its purpose is an open question.
It's true that mandatory purchase doesn't necessarily lead to market power, auto insurance is quite competitive. Nevertheless, given the potential of insurance reform to increase the market power of insurance firms the search for some disciplining device like the public option is reasonable. Other useful reforms would be to have a single, national regulator of insurance - rather than the 50 we have now, allow an optional federal charter (as we do for banks) or (my preferred approach) move to a competitive federalist system for insurance similar to that for corporate charters."
Economist Paul Krugman says this about the the importance of a public option and why co-ops will not work.
"One purpose of the public option is to save money. Experience with Medicare suggests that a government-run plan would have lower costs than private insurers; in addition, it would introduce more competition and keep premiums down.
And let’s be clear: the supposed alternative, nonprofit co-ops, is a sham. That’s not just my opinion; it’s what the market says: stocks of health insurance companies soared on news that the Gang of Six senators trying to negotiate a bipartisan approach to health reform were dropping the public plan. Clearly, investors believe that co-ops would offer little real competition to private insurers."