Why is private health insurance such a disaster?

Why does private health insurance perform so badly in holding down costs? (Here is one story.) I can think of a few hypotheses:

1. Medical ideology portrays doctors as a priestly caste, accountable to no one.

2. The observed cost increases are driven primarily by government reimbursements and purchases.

3. The tax-free nature of employer-supplied insurance benefits encourages wantonness. (TC: Why? You can subsidize the purchase of apples, that doesn't mean apples will be produced inefficiently or at "excess cost" for that level of apple output.)

4. The tax system discourages insurance policies with higher copayments. (TC: But if copayments are so great, companies today could offer higher-valued benefits along other dimensions, while increasing the copayment rate.)

5. Malpractice suits. This one is true for sure, but put it aside since the problem goes much further.

The most plausible answer is:

6. It is hard to contract in advance for which services should be covered. If you let everything be covered, costs skyrocket. If you allow for "outs," insurance companies will use these loopholes to cut off high cost patients, thereby eliminating the benefits of insurance.

But why should this be such an insurmountable problem? Why can't impartial third-party arbitrators arrive at a coverage solution that is reasonably efficient? After all arbitrators settle millions of legal disputes, issues where conflicts of interest could not be more pronounced. Or imagine third-parties that evaluates whether an insurance company covers reasonable expenses or instead screws over its customers?

Yes this does mean a cost-monitoring bureaucracy. But surely under all health care systems someone must decide which treatments are worthwhile or not. Why cannot markets allocate this function to the least cost decider? Why does the usual solution -- intermediation -- appear to be working so badly?

Inquiring minds wish to know. And simply citing the very large role for government in the American system does not do the trick. Here is one Cato account, you can agree with many of the points but it doesn't answer my question. Here are some broader market-oriented links.

And this is why I find it so hard to come up with a good plan for health care reform. If we don't understand why private health insurance functions so badly in our mixed system, we won't understand how to fix things.