There are no quick fixes for what ails our healthcare system – in spite of what many policymakers and the media would like to have us think. Medicare-for-all or the public option would definitely provide insurance coverage for the millions of Americans who are still without. And, they might have marginal effects on the cost of care by reducing bad debt and increasing the use of preventive services to keep people from becoming so sick that their costs of care are excessive.
But, the U.S. healthcare system is governed by a complicated, convoluted set of programs, regulations, and competing interests that result in massive administrative complexity and costs in ALL parts of the system. To avoid the balloon effect of pushing on one place only to have another problem develop elsewhere, the solutions must address how the system is structured as well as how it is financed through insurance coverage.
Even protections we once had in place to limit profiteering are pretty much gone – chipped away by decades of legal and regulatory change at the federal, state and local levels. And, the system has become so fragmented through the enactment of one new, limited program after another, that it lacks any resemblance to efficient design, offering scant opportunity to gain scale economies. Even health insurers with nationwide reach are often organized at a local level, to accommodate differences in state regulatory requirements and the constitutional prohibition on federal regulation of commerce that crosses state lines.
The result is one of the largest and most highly fragmented economic segments in the world. It’s sheer size and design makes it ripe for speculation and financial engineering, which is why we’ve seen absurd and inexplicable increases in pharmaceutical and medical device costs as private equity has trolled the industry for opportunities to extract monopoly pricing power. Fixing this mess will mean unwinding a tangle of programs across the industry and, in some instances, instituting some of the types of mechanisms that used to be in place, and which are still used elsewhere to control the costs of care.
So, what are some of the features of the U.S. healthcare system that have gotten us to where we are?
The Scientific Model of Care and Its Impact on Costs
The formation of the American Medical Association (AMA) which was incorporated in 1897 (formed in the 1840s) and the American Hospital Association (AHA) founded in 1898 led to the establishment of standards for medical education, licensing, delivery of care, and health facility management and quality. They ushered in a new scientific model of medical care that changed how and where care was delivered, and what it cost. Care, that had largely been delivered in the home and may or may not has been overseen by a physician trained along scientific standards, moved into hospitals. A new, higher cost, an interventional model of health was born and control over licensing and regulation was largely ceded to the industry. (We’ll discuss this in greater detail in Part 2 of this article.)
The effects of these changes continue to reverberate through the healthcare system in the U.S. and many other western countries, reducing competition and slowing innovation through licensing and regulatory schemes that act as barriers to entry – limiting who can practice medicine, and how.
Both of these organizations’ professionalized American healthcare, became a model for programs across the globe and still have a profound effect on how our system is structured. However, it wasn’t long before these changes, along with changing health technology led to significant increases in the costs of healthcare as those stricter standards led to decreased physician supply and greater pricing power for both physicians and hospitals.
As the effects of these changes took hold and care that had previously been delivered in the home began moving into the hospital setting, hospital costs grew from approximately 14% in 1929 to 40% of medical bills by 1934. The age of big, institutional medicine had arrived. And, consumers were already pushing back with increasing calls for reform and the creation of national health insurance plans similar to those already created in some western nations.
America’s Belief in Volunteerism and Decentralized Power
While those calls for reform threatened to undermine the power of these new organizations, they also conflicted with America’s belief in personal responsibility and the value of work. And, this combination of forces led to dramatic differences in how healthcare was delivered and financed in the U.S., who would pay for it, and who had access. The result was an American healthcare system that is seriously fragmented and has been different from other countries pretty much from the beginning. And those differences profoundly impact the solutions we are willing to consider.
The dominance of these industry organizations, along with American beliefs in self-initiative, personal responsibility and volunteerism meant the emergence of community and religious-affiliated hospitals and mutual insurance companies to a degree not seen in other countries. When combined with our federal structure and constitutional prohibitions on federal regulation of NON-interstate commerce this contributed to a fragmented system with much of policy and decision making at the state and local level and virtually no national health planning.
The rural healthcare crisis in much of the U.S. and our slow uptake of solutions like telemedicine and the use of non-MD practitioners and para-professionals to deliver care are all largely a direct result of these differences.
Those institutions, including the Blue Cross and Blue Shield plans which grew out of them, were the original backbone of the system. And, through their association with those organizations, they were able to extract special legal and regulatory treatment that allowed them to limit competition and gain monopoly pricing power that still affects the structure and costs of healthcare in America.
The Emergence of Private Health Insurance
To address the growing problem of affordability and the lack of government solutions, employee organizations began entering into prepaid health services agreements with individual hospitals to provide care to their members. The first of these was the Dallas teacher’s contract with Baylor University. The original Blue plans arose in this environment as the American Hospital Association formed the not-for-profit Blue Cross insurance plans as an alternative to the prepaid agreements. It still covered the hospital services they were already delivering, but it also controlled the types of agreements that could be made.
Contract provisions included hospital participation requirements prohibiting the selling of single-hospital plans that might be able to offer reduced pricing of their services and limited competition between hospitals. The association also limited the number of plans that could operate in any market – to ONE – prohibiting the plans from competing with one another and limiting options for consumers.
From the beginning, these plans, which were not-for-profits, benefitted from regulatory protections that reduced competition, including exemption from taxes and insurance surplus requirements. In exchange, the plans were typically required to act as the “insurer of last resort” and only use community-rating (more about that later) for their products.
Because the Blue plans were voluntary associations and tax-exempt social-welfare plans, with the special regulatory status they also largely escaped any of the anti-trust oversight they would have otherwise had. Without those limits those anti-competitive features went largely unchecked for decades, allowing most to establish dominant market shares that persist to this day.
Within the decade, the Blue Cross plans were followed by the creation of Blue Shield plans by the doctors of the American Medical Association. Formed in the late 1930s, they were intended as an alternative to growing calls for compulsory health insurance, and to fill the gap in coverage from the hospital-focused Blue Cross plans. From the beginning though, they also included many of the same competition-limiting features and special regulatory exemptions.
Employer-Sponsored Coverage as a Safe Business Opportunity
For-profit insurers originally resisted the offering of health insurance because of the risks of “moral hazard” (the fear that only sick people would buy it) and perceived difficulties of actuarially sound underwriting of the product. (How could they price a product if they didn’t know whether people were sick or healthy?!). Besides, many of these companies already had lucrative businesses selling burial insurance (more of a sure bet) and laws in many states prohibited the selling of both health insurance and burial insurance – an obvious conflict.
However, as the success of the Blues became more apparent and the health insurance market grew, these for-profit insurers sought out new ways to participate – profitably. And, while they didn’t enjoy the regulatory protections of the Blues or their competitive benefits of close affiliation with hospitals and doctors, they also didn’t have the constraint of being the “insurer of last resort”.
So, they began looking for opportunities to participate while limiting their risks. The answer was to focus on a slice of the market which they believed was inherently healthier – those who were employed. Since these plans were for-profit and not tax-exempt they also were not subject to the same restrictions as the Blues. This means they could medically underwrite, further limiting their risks. And with that, the group health insurance market, with coverage linked to employers, was born.
It incidentally played right into America’s obsession with personal responsibility and the value of work, while adding to the fragmentation of coverage and incremental solutions targeting limited groups of citizens with different programs.
So, while other developed countries were implementing national health insurance programs that covered ALL populations and supported system-wide planning of resources, discussion of social safety net programs in the U.S., even during the Great Depression already emphasized program design linked to employment.
The result was a whole series of solutions to fill gaps in coverage rather than establishing comprehensive coverage for all citizens. And, the narrow interests that had designed each of these different coverage options – hospitals, physicians, and commercial insurers — found common cause to limit government intervention to protect their slice of the market.
Employer-Provided Coverage Becomes the Law of the Land
The challenges of supporting the industry with a workforce drained by the demands of the draft during World War II added to the attractiveness of employer-sponsored coverage. Employers, who were limited in their ability to offer pay increases due to price controls during the war, saw pre-paid health programs as an important tool to keep their workforces healthy and recruit employees since the offering of benefit plans was exempted from these prohibitions. This shift to employer-driven coverage was cemented by changes in the Internal Revenue Code during the 1950s, which exempted employer health contributions from taxation.
By the early 1960s, the health insurance industry had already exploded, with 70% of the population having some form of HOSPITAL insurance, but the major medical insurance industry was only beginning to emerge. The idea of insurance for primary care and non-hospital care had not yet taken hold, though there were some exceptions. Veterans had access to the Veterans Administration system which had been established after the Civil War, and federal employees had access to more comprehensive coverage.
This was before the creation of Medicare and since they were likely not employed, fewer than one-half of elderly Americans had any insurance at all. Although some did qualify as “medically indigent” and could receive state-delivered services under the Kerr-Mills Act. Because coverage was so closely tied to employment, the same conditions applied to the unemployed and those receiving welfare benefits.
Creation of the Original Medicare and Medicaid Programs
Some of these remaining gaps in coverage began to be addressed with the passage of the Medicare program in 1965. The program, which was an outgrowth of a conference on aging held by the Eisenhower administration, initially covered primarily the elderly and included Part A hospital and skilled nursing services (with restrictions) and Part B for non-hospital services provided by physicians and others.
In keeping with the fragmented, incremental approach to coverage, even the funding mechanisms for the two programs were separate, with Part A being funded through the Social Security payroll tax, and Part B funded by premiums paid by Medicare beneficiaries, with supplementation from federal general funds. And, once again, primary coverage (Part A) was linked to employment, so that individuals who had not paid into Social Security (or who had a spouse who did) were generally excluded from coverage under the original program design.
Interestingly, the close linkage to both hospitals and doctors, and to the Blue plans also continued with the formation of the program. Under Medicare, it is physicians associated with the AMA who advise the government on prices for Medicare services, with a similar process for hospitals that submit cost reports that become the foundation for reimbursement calculations. Much of the administration of the program was also outsourced to the Blue plans, who took on responsibility for claims processing and related activities as MAC contractors.
Following the same approach to coverage expansion, the separate Medicaid program was created at roughly the same time and followed a similar pattern of fragmented and incremental design – but to an even greater degree. First, what many people don’t understand is that Medicaid is largely a voluntary program for the states. They don’t have to participate. Remember the first assault on the ACA when the Supreme Court ruled that the states couldn’t be forced to expand Medicaid? That’s what we’re talking about. States need to opt into the program and must fund a share of the program at what is approximately 50% of the cost.
The original Medicaid program was also a skinny, skinny program that provided coverage for only a limited number of individuals and for limited services. It covered people getting cash assistance, low-income children deprived of parental support, their caretaker relatives, low-income elderly, the blind, and individuals with disabilities. This excluded most able-bodied adults – the assumption being they could work and get their coverage that way.
Original Medicaid benefits were also limited and varied between the states. States had minimum coverage they had to provide in order to receive Federal matching funds but had some limited ability to provide additional coverages. Some states did add benefits, although most offered the minimum (and some states still do). The program also covered little in the way of preventive care and mental health services — following the model of the early private insurers. Yet again, we had implemented a program that practically ensured massive variability.
So, by the late 1960’s we’d made some significant leaps forward, with more and more Americans having coverage. But, that coverage came from a patchwork quilt of programs and products that still left a large number of Americans uninsured. By 1968 roughly 81% of Americans had some form of hospital or surgical insurance. What that left was almost 20% of Americans with no coverage and an even larger number without coverage for basic preventive and primary care.
Probably, more importantly, we were also left with a seriously fragmented system. And, it was hooked on a model of incremental expansion that only contributed to that fragmentation. It was also a system that was largely directed and regulated by the very interests that stood to benefit financially from the decisions being made – and who were legally protected from the kind of competition that might have fostered innovation while being insulated from many anti-trust limitations.
As we entered the 1970’s, these same factors continued to play out. But, a whole series of new actors, new programs and new regulatory models started to gain traction. The result was a hodgepodge of federal and state programs (that persist to this day) and the dismantling of the few industry limitations and consumer protections that had been in place. By the end of the decade, healthcare was already becoming big business and healthcare costs were on the march again.
At the beginning of 1970 U.S. healthcare spending totaled $74.6 billion and was 6.9% of GDP. By 2018, spending would equal 17.7% of GDP and a whopping $3.6 TRILLION.
In part 2 of this article, I tackle the question of those changes that were made, and that brought us to our current state – a healthcare industry that is nearly 20% of our economy, and which is failing to deliver the kinds of outcomes citizens of other developed countries expect.
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