History of Health Insurance

Before the 1930s, very little care was available from any health care system other than making ill people comfortable until they died. In 1900, the life expectancy in the United States was only forty-nine years, with many individuals dying at an early age from influenza, tuberculosis, and even diarrhea because no highly effective treatments were available. There was little medical technology available; antibiotics for acute illness were not discovered until the mid-1930s. Most medical care was supplied in the home and not the hospital. Moreover, medical care was inexpensive, and therefore there was little need for health insurance. If you became ill you would simply pay out of pocket for what medical care was available. Health care services were affordable because when you became ill you were cared for in the home by family members or by charitable organizations. Buying health insurance or providing health insurance simply did not make any sense when the risk of a catastrophic financial loss (a key determinant of demand for insurance) was low. A market for health insurance comes into being when potential profits from supplying insurance can be seen because large numbers of people are demanding insurance. Such was not the case during that period of time.

Health insurance for the majority of the American population began its long-term growth phase shortly after World War II. As health care costs began to increase, a market for private health insurance (also known as commercial health insurance) developed. This insurance was initially a very inexpensive product and large numbers of people demanded it. Some organizations offering commercial health insurance were nonprofit and some were for-profit, and they usually offered both group and individual insurance plans.

The wage and price controls of the 1940s limited the ability of employers to raise wages to attract and retain employees. So employers started to use health insurance and other nonsalary benefits to lure workers. Labor unions also were in a strong position to demand and receive health insurance as part of a comprehensive, employer-funded benefit package. Starr (2011) points out that federal authorities allowed companies to add health insurance as a benefit for employees despite the wage and price controls that were in place. The cost of this new benefit of health insurance was allowed to be tax deductible for employers and eventually was treated as nontaxable income for the employees receiving the insurance. Under these conditions, health insurance coverage expanded rapidly across the United States. Newly insured employees were now able to afford more expensive health services, which became the incentive required to create new ways to treat illnesses; demand then increased for hospital construction and expansion to deliver the new medical technologies.

Medicine became big business with the expansion of new, higher- cost treatments and the increased numbers of physicians and hospitals in the United States. As more health care providers entered the market, competition increased among them, which, interestingly, increased the amount of services provided. This reflects a unique feature in the health care industry – provider-induced demand. The average consumer of health care does not know how to diagnose his or her medical condition and does not have a license to order services or prescribe medications. So consumers rely on the knowledge of a health care provider to determine what services are needed, even though that provider stands to make more money by ordering more services. As competition increased, providers could maintain their incomes by recommending more services to the persons they served.

provider-induced demand

Demand not made by the consumer but induced by a third party.

Insurance benefits may not be very valuable to the person covered by insurance in the short run unless they are used. Insurance made patients insensitive to the cost of medical procedures and hospitalization because they would now have to pay only a small part, if any, of the cost of medical services. This leads to the condition known as moral hazard (discussed in Chapter One), in which an individual is more likely to take risks when the costs associated with the risk are borne by another. In this case, the very existence of health insurance coverage creates an incentive for the insured individual (also known as the beneficiary) to use the benefit.

moral hazard

A condition that exists when an individual is more likely to take risks because the costs associated with the risk are borne by another.

beneficiary

An individual who receives proceeds or benefits from, for example, an insurance policy.

Thinking to reduce moral hazard, many insurers attempted to share some costs of care with the insured person. Cost sharing happens in three different ways. First, the insurance policy may specify a deductible, where the insured person pays a specified amount before the insurer pays. Second, the patient may be asked to pay coinsurance, which is a percentage of the payment for services. Third, the patient may have a copayment, where the patient pays a flat amount each time he or she obtains services. Insurance plans may have one or more of these cost-sharing mechanisms. For example, an insurance plan may have a $500 deductible with a $25 copayment for physician's office visits.

deductible

An amount paid by the insured before the insurer pays.

coinsurance

A percentage of the service costs paid by the insured.

copayment

The amount paid by the insured each time the service is utilized.

As providers continued to increase the volume of services provided and the prices paid for those services, the escalation of health care costs mentioned earlier in this chapter began to manifest itself. Health care providers began to operate more like businesses, with profit and market share expectations, which further fueled this upward trend in health care costs in the United States. As insurers and consumers began to push back against inflation in health care costs, reductions in payment rates and mechanisms to limit the volume of services provided, an approach known as managed care (described later in this chapter and in more detail in Chapter Seven) came into vogue.

As costs have increased, so has interest in the financing of health care services. Providers of health care services in the United States have worked hard at fighting efforts to reduce payments and in fact have made concerted efforts to see that their payments continue to increase. Because the government has become one of the largest payers and the only regulator of the health care industry, it has become a major goal of health providers to gain the attention of the various legislators through lobbyists. Stiglitz (2012) points out that there are more than 3,100 lobbyists working at the federal level on behalf of various health care interests, or six for every one of our federal legislators. These lobbyists work to influence the health care legislation that in turn influences provider payment for services. Therefore health care finance is a result of political forces as much as economics.

The success story of improving health care technology has led to an increased life expectancy in the United States. However, this success has also had the secondary effect of increasing the prices of health care services beyond the reach of the average American. The need for reform of our health care delivery system has never been greater but this reform will involve much more than finance. Developing reforms that will affect the cost of health insurance requires gaining a better understanding of how the health insurance market works.