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Trends, Costs  in Healthcare

Excerpts from:  Health care in the twentieth century: a history of government interference and protection

Business Economics, April, 1993 by Terree P. Wasley this kind of a mess? An investigation into the evolution of the medical industry in America will expose not the competitive market that most Americans assume has been operating, but stifling regulation and government control as well as regulations originating from interest groups such as medical organizations and insurance companies. This system is chaotic for both doctors and patients and is one that appears to be a free-market operation but is really an industry legislated and regulated from behind the scenes.

The major development in health care during the 1940s was the growth of employer-provided health insurance.  Collective bargaining agreements expanded the scope of coverage as well as employers' contributions. By the end of 1954, more than 60 percent of the population had some type of hospital insurance, 50 percent some type of surgical insurance, and 95 percent medical insurance.  In 1945 employers paid only 10 percent of health care expenses, but by 1950 collective bargaining agreements were requiring them to pay 37 percent. And, in 1959, the United Steelworkers ended a 116-day strike when a settlement was reached that required the steel companies to pay the entire premium for health insurance. General Motors, Ford, and Chrysler followed with similar agreements in 1961. 

An entirely new system of health care financing was created during the decades of the 1940s and 1950s. Government encouraged the development and expansion of provider-oriented insurance plans that ultimately distorted the health care delivery system. Employer-provided plans offering first-dollar (front-end) and routine care coverage contributed significantly to the rise in health care costs. The preponderance of employer-provided insurance worsened the position of those without health plans because of the inflationary effect of third-party payment.

Why do people purchase first-dollar, routine care coverage for health care when they wouldn't think of purchasing that coverage for their automobile? Simply stated, they do so because the tax code encourages them to do so. Health insurance plans are viewed as tax-free compensation, not as insurance. Workers then favor coverage that pays for routine care, freeing up their discretionary income for other uses. Insurance is no longer used for its normal purpose of spreading risk, but for tax avoidance.

...government intervention generated another problem in the industry -- "experience rating."  Commercial insurers turned to "experience rating" their insurance plans as a way to compete against the Blues (Blue Cross and Blue Shield). They began to sell insurance to employers with relatively healthy, low-risk employees at cheaper rates than the Blues. Since the Blues often were required by law to use a "community rating" system, they responded to this competition by receiving permission to use a "modified" community rating to reflect experience.  Insurance companies calculated premiums for group plans based on those working for a single employer.

As a result, smaller companies with fewer employees over whom to spread costs generally must pay more for insurance. Additionally, they face the risk of large premium increases or even cancellation if only one employee becomes ill. Had the government not intervened on behalf of the Blues and provided them legislative protection, the "experience rating" system might not have developed, a system that results in a significant portion of small businesses not able to afford health insurance coverage for their employees.

The expansion of employer-provided health care accentuated the medical needs of those without insurance, primarily the unemployed, poor, and elderly. As the 1960s began, pressures began to build for some sort of government health program that would provide care for these groups. Dissatisfied with a piecemeal approach, champions of the New Deal programs of the 1930s began agitating anew for a national health plan, while groups such as the AMA, fearing adoption of such a program, advocated decentralized, state-administered programs that would maintain the autonomy of physicians and hospitals. A compromise was reached in 1965, and the Medicare program was born.  In an instant, with the passage of Medicare and Medicaid the federal government became the largest single purchaser of health care.

The third-party payment system now dominated the health care industry. Most Americans were covered either by private health insurance or a government program for their hospital and physician costs. But Medicare and Medicaid brought the same defects found in the private insurance industry to the health care landscape, accelerating the rate of medical price inflation already set in motion by cost-plus reimbursement, lack of patient incentive to control costs, and first-dollar coverage.  In response to White House pressure to get the plan off to a running start, the Department of Health, Education, and Welfare wrote regulations regarding reimbursement that were extremely beneficial to the medical industry.

As costs continued to escalate through the 1970s and 1980s, what did government do to rectify the situation?  Did it rescind the tax incentives, laws, restrictions and regulations imposed on the health care market that skew behavior and result in increased demand for medical care with little concern for cost?   The answer to this question is No. Instead of removing the controls, incentives and restrictions that were distorting the market, the federal government attempted to stifle the outcome of bad policies with a whole host of new controls and regulations. The focus of all the legislation in recent years has been to control medical prices and hold down costs, specifically by applying additional restrictions to physicians, hospitals, and even patients.

Health Maintenance Organizations (HMO) were created and promoted by Congress in 1973 as a solution to rising costs. They fell under a significant amount of regulation, including requiring all companies with twenty-five or more employees to offer an HMO plan to their workers. As a result of grants and loans to encourage HMO growth, and employer interest in controlling health care costs, HMOs grew from twenty-six plans with about 3 million subscribers nationwide in the early 1970s to 556 plans with 35 million enrollees by 1991.

In 1983 a major effort at controlling Medicare costs was a provision within Social Security legislation that established a "prospective payment system" (PPS) for hospital reimbursement. Under this system, Medicare establishes a fixed schedule of fees that it pays hospitals for the treatment of each of 475 "diagnostic related groups" (DRGs) of illnesses. If the actual cost to the hospital is less than the DRG fee, it keeps the difference; if more, it absorbs the loss. The purpose was to encourage price consciousness and competition among hospitals.

The PPS has caused the same shortages and misallocations that any price control system would cause and has done so by shifting costs to activities not covered by the controls. Not surprisingly, costs in the Medicare program have continued to rise. In the five years following the introduction of PPS, the average annual rates of growth in Medicare spending were 6.5 percent for the Hospital Insurance program and 13.8 percent for the Supplemental Medical Insurance program,(16) much higher than the overall rate of inflation.

Mandated benefit laws are enacted usually as the result of lobbying from health care providers and advocates seeking coverage for various diseases. They require insurance companies to pay for specific medical services.

In 1970 there were only thirty state-mandated benefit laws nationwide; today there are at least 800. They are also a major reason why many people lack health insurance -- state-mandated benefits increase the cost of insurance and price many people out of the insurance market.


In spite of the best efforts of business and the presumably good intentions of government, health care costs are still out of control and rising. The problem remains: Until we change the fundamental defects in the system, no amount of tinkering will result in a significant slowing or reversal in the direction of increased costs. The government's hodgepodge of health care programs, its continual interference into the market, and the protection of its (and the medical communities') preferred methods of care, have distorted the market and created a built-in structure of cost escalation.

Recent calls for overall reform of the health care system have brought forth a plethora of plans.  Most receiving attention involve more government control and regulation, such as global budgets and the forced use of managed care.  These "solutions" will prove to be band aids and will not provide a permanent resolution of the health care problem.  The only solution to rising health care costs is to allow a system based on the market, one that offers citizens maximum freedom of choice and responsibility in purchasing their health care.  Only then will we see a health care system offering sufficient coverage and good quality care at costs that all Americans can afford.