Evolution of Health Insurance In The US

Did you ever wonder how we got where we are today with Health Care? It started in Dallas around 1929 as a reaction to the stock market crash and financial meltdown. The business problem for Baylor University Hospital in Dallas was that it didn’t have enough money to pay its bills. Prior to the stock market cash, hospitals raised funds by paying customers who were billed for services rendered or the wealthy would donate to the hospital because it was a good place to donate your extra money (charity made one feel good and was good for the community).

With the stock market crash, the wealthy didn’t have as much money to donate, unemployment increased and hospitals were having a difficult time.

Baylor University Hospital made a deal with the Dallas School System. They said, “School system, you raise money from taxes. You always have money. Pay us $.50 every other week for each of your employees and when they get sick, they come to us and we’ll take care of them.”

Health insurance started as a mechanism to protect and finance hospital income.

Consumers soon wanted more choice than just one hospital so independent insurance carriers formed to offer a choice of hospitals beginning in the 1930s. Then the doctors, who were in the same situation as the hospitals financially, wanted in too. Blue Cross was for your doctor’s bills and Blue Shield for your hospital bills. Both were organized to protect provider incomes.

The Blues developed a couple of very clever ideas in the 1930s. First they offered a choice; second they began searching for the healthy subscribers so they could lower their rates, spreading the risk, in what became to be known as a community rating.

This insurance financing system has little to do with getting people healthy. That was not its intention. It was designed to protect physician and hospital income.

World War II had a major impact on health insurance development (1939 to 1945). First, many soldiers had health coverage in the military and wanted it in civilian life. Second, the wartime economy stimulated development of new medical technologies. Third, the government fostered the fringe benefit movement through wartime wage and price freezes.

• 1942: 10 million hospital insurance / health insurance subscribers
• 1946: 32 million hospital insurance / health insurance subscribers
• 1951: 77 million hospital insurance / health insurance subscribers

The government decided during the War to freeze wages and prices. But the government allowed employers to offer “fringe benefits” such as health insurance. This was how employers could attract new talent and retain their current employees. The concept of “fringe” meant outside the normal compensation and “benefits” meant advantages of working here.

In 1953, the IRS made fringe benefits tax deductible to the employer and were not considered income taxable to the employee. This was essentially a government subsidy of hospital care – since that’s what health insurance ultimately financed. Essentially, the government stimulated sales of employer based health insurance by subsidizing the price. If you subsidize health insurance in an employer based model, employers provide more and employees get more. The health insurance subsidies – via tax deductibility of fringe benefits – lead to healthcare inflation from higher hospital prices (because more people could afford to use hospitals).

In the mid-1950s, about 45% of Americans had hospital insurance. By 1963, 77% had hospital coverage, and an additional 50% had some form of physician coverage. Over this time period two strange incentives evolved in our healthcare marketplace: an excessive hospitalization incentive and an incentive to cover the unemployed. These two conditions merged in the late 1960s and 1970s. Their combined effect became clear by the 1980s as our health insurance costs skyrocketed and our employer based financing model became even more firmly entrenched.

By the mid-1960s over three quarters of Americans had hospitalization insurance, paid for by employers and subsidized by the government. Hospitalizations became essentially free to patients a not-so-subtle perverse incentive to hospitalize individuals. This was the case even for diagnostic tests that could have been performed on a less costly outpatient basis.

Since medical care became more costly, insurance became more necessary. In turn, the presence of insurance helped underwrite a buildup of resources and an upgrading of technology that added to costs and made insurance even more valuable. Remember the incentives here. Employees liked the system because it appeared free to them. Hospitals loved the system because they received patients and insurance payments – a wonderful recipe for making money.

Hospital insurance stimulated the excess use of hospitals, which created more need for hospital insurance. Two byproducts: First, we used hospitals for almost all medical care, even if less expensive settings existed. Second, we developed fewer outpatient, home based, preventive or non-hospital types of medical care.

It turns out that in the past 40 years or so, many countries in the world were either recovering from World War II or gaining independence and expanding their educational systems.

They were not economic threats to the United States – countries like Japan, India, Korea, China, or Western Europe. We dominated economically; could keep prices high and afford health benefits.

Our big firms in particular were very profitable (i.e., GM, US Steel, ALCOA, AT&T); they didn’t have much foreign competition. They could afford to pay for employee healthcare. They could raise prices because nobody was competing with them to keep prices low. That’s the trend that you see from World War II to about the 1980s. Big firms could set the standard and then small businesses filled in the holes. They had to compete for labor based on offering health insurance, and they could because the big firms were managing the world economy.

All these conditions changed in the 1980s and 90s.

Our ability to generate excess profits, if you will, to afford for the employers to pay for healthcare starts to disintegrate as foreign competition gets going. From World War II until about 1980 or 1990 we could afford employer based health insurance and there was no significant political group that was lobbying or arguing against it. The system worked for most people.

By the 1960s, a large number of non-working Americans needed health insurance. This group could have demanded a national, universal type of health system. But Medicare and Medicaid covered these people and removed a potential political threat to employer based coverage. Ultimately, covering these people on Medicare and Medicaid supported the employer based insurance model.

Year      Number Medicare Enrollees       % of US population

1970              20 million                                            10%

1980              28 million                                            12%

1990              34 million                                            13.5%

2000              39 million                                            13.8%

Medicade covers about the same population size.

The employer based system reaches its peak of 165 million people in 2000 and then it started to decline. It declined because the international economic conditions changed. American firms could no longer pass on benefit costs to their customers.

At the same time, the hospital lobbies and related groups had done such a good job of protecting their constituencies that healthcare became hugely expensive. Healthcare grew from about 4% of US GDP in 1950 to 14% in 2000.

So, by the end of the 1900s, our healthcare costs – primarily hospitalizations due to the government subsidies of fringe benefits – rose far faster than GDP. Meanwhile, American businesses’ abilities to pay for their employees’ health coverage diminished in the face of foreign economic competition. So that is how we got where we are today…

A Look At An Ideal Health Care System and Player Motivation

An ideal healthcare system could be conceptualized having four basic components.

1. You’d have a lot of preventive care to keep people healthy and keep them out of the hospital because that’s cheap and they live longer. This would be done through nutrition, weight control, exercise, and other types of prevention.
2. You would focus on chronic disease care because 70% of healthcare costs go to chronic disease care. You’d have regular monitoring; regular interactions with your doctors and you’d have teams. You would be able to go into the clinic for diabetes, or see a podiatric person, a psychologist, a kidney doctor or a hematologist. You’d see lots of different specialists working together as a team to try to come up with a treatment plan for you.
3. You would have good quality, safe, acute care – not necessarily the cheapest care; 
4. You would have good caregiver coordination with your acute and / or chronic care.

Good health is less expensive than poor health. A system that’s working well, keeping people healthy, would be the least expensive system of all. When people get sick, we return them to good health quickly.

 What motivates health care decisions of different players?

Employers

Employers supply health insurance benefits mainly to attract and retain good employees. Employers don’t, as an economic function of their business, aim to get people as healthy as they possibly can. They’re interested in selling widgets and to do that they need to get good employees. For an employer, “good enough” healthcare is “good enough” because they want to make widgets. Employers are interested in short term healthcare commitments (generally 1 year). The employer often can not predict the firm’s financial health far into the future so they want to avoid committing to long term liabilities. The employee census could change, business conditions could change, etc. So carriers compete for employer business by showing the lowest year-to-year premium increases.

In healthcare, short term cost control always leads to higher long term costs. Remember that 70% of our healthcare spending goes to people with chronic diseases. Short term cost control often means skimping on this year’s preventive or maintenance treatments – resulting in higher costs in the future.

Employees

Employees want excellent healthcare. When diagnosed with cancer, for example, they do not want to hear about cost control issues, or 1 year policy issues, or comparative health insurance premium increases. They want to get cured as fast as possible. Employees want access to the “best” hospitals, not just the “in network”. They also want true prevention. In effect, the employees ask “Why must I wait until prevention fails before receiving medical care?” In economic terms this is inefficient: it adds cost without adding value. It adds cost since this requires the best possible technology even if it only helps a little bit; and a surplus of recourses so there are no wait times.

Carriers

The carriers, who insure or finance our health care costs through premiums, respond to employers because employers buy are the ones buying policies. Carriers compete on short term cost control, not on long term cost control, not on total disease cost controls, not on quality. Carriers do not reward excellence. They only reward short term cost control because they respond to employer purchasing criteria.

The carrier says to the employer “You want one year policies? We’ll give one year policies. You don’t mind out-of-network restrictions? We’ll give you out-of-network restrictions.” They want to put off expenses because maybe the sick person will switch to another carrier before needing expensive care.

When you have the market going after healthy people to reduce adverse selection and try to put off large expenses, the government steps in, with nursing staffing ratios and mandated coverage and other requirements. The government puts a band-aid over the problem that shouldn’t have existed in the first place, adding additional costs and little or no value.

Government

The government enacts mandates to protect patients from abusive short term cost controls. The government says to the carriers “You have to cover these services.” The carriers respond “We don’t want to cover those services. It’s going to raise premium prices.” The government then passes regulations and imposes mandates – in effect saying to the carriers “Now you have to cover these services.” But mandates don’t seem to affect healthcare outcomes very much. Mandates reflect the political power of special interest groups. The need for mandates arises because of inappropriate short term cost controls. Estimates show mandates along represent 10 – 12% of all healthcare costs in some states.

The downside of all this is that the more the government gets involved inappropriately – fixing problems that it shouldn’t be fixing in the first place – the more we raise healthcare costs. 

What are your thoughts?

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