Private Health Insurance Originates with Blue Cross and Blue Shield

Photograph

By: Blue Cross Blue Shield Association

Date: 1954

Source: Blue Cross Blue Shield Association. "History of Blue Cross® Blue Shield®." 〈http://www.bcbs.com/history/bluebeginnings.html〉 (accessed October 20, 2005).

About the Author: The Blue Cross Blue Shield Association is an umbrella organization representing state and regional Blue Cross and Blue Shield health plans across the United States. It provides public relations, research, and infrastructure services to the individual plans.

INTRODUCTION

Prior to 1920, expenditures on hospital and medical services were relatively low for most Americans, as physicians and hospitals had far fewer technological tools and drug therapies at their disposal with which to treat their patients. The loss of income from disability due to illness often had greater economic impact than paying for medical care, and people often purchased "sickness insurance" similar to contemporary disability insurance rather than health insurance to protect income. A 1918 government survey found that people spent less than eight percent of their incomes on medical expenses.

At the same time, commercial life insurance companies did not believe that they had the expertise and understanding of health risk to offer health insurance. They feared they would be financially victimized by "adverse selection," in which people with serious illnesses or engaged in the riskiest behaviors would purchase insurance, while the healthiest and safest people would forego health coverage.

During the 1920s, the training of physicians became more scientific, emphasizing knowledge of bacteriology, infectious agents, diagnostic testing, pharmaceutical treatment, and disease prevention with vaccines. Doctors became more professionalized and began to charge higher fees. The demand for clean, well-equipped hospital facilities with room to care for patients outside the home increased with growing urbanization and the lack of room in city dwellings to care for the sick. The economic burden of illness began to grow, making financial preparation for its eventuality prudent. As the decade of the 1920s progressed, the cost of medical care became a topic of growing concern and public debate.

It was logical that employers in high-risk occupations, such as mining, and schools employing many women (for whom high maternity expenses could be expected) would see the economic value of purchasing insurance for medical care to ensure that patients could pay their bills. Such pre-paid employer health plans were originally contracts between specific employers and hospitals or physician associations. During the early 1930s, these agreements became so widespread that the American Hospital Association (AHA) encouraged its members with pre-paid health plans to coalesce under the Blue Cross moniker. The AHA's motivation was both to encourage the development of programs that protected the economic well-being of the population and to reduce price competition among the hospitals.

A similar amalgamation occurred among physician programs under the Blue Shield name. Physicians were not so averse to price competition and price discrimination, but worried that intensifying national concern over medical costs would lead to government regulation. Also, they worried that the hospitals under the Blue Cross system would begin to offer insurance for medical services as well. They protected their interests by organizing into Blue Shield plans and preempting both Blue Cross and advocates for establishing national compulsory health insurance. Initially, Blue Shield plans covered medical and surgical expenses while patients were hospitalized, but later they covered physician office visits and services as well.

The photograph of the first person whose birth was financed by Blue Cross is part of the Blue Cross and Blue Shield Association's effort to educate the American public about the origins of the complex U.S. private health care financing system. When the photograph was taken in 1954, the Blue Cross system had already been in existence for more than twenty years. The story of the picture takes a twist when the caption explains that the first "Blue Baby" is not the baby in the picture, but the mother. This underscored the increasingly critical role that Blue Cross programs had come to assume in the financing of health and maternity expenses for a widening group of Americans.

Blue Cross programs arose during the hard economic times of the Depression (1929–1939) when hospital expenses were beginning to be of material concern to families. Blue Shield programs, which pay for physician services, had a nearly simultaneous, but independent origin that was fostered by efforts of workers engaged in difficult and risky labor to finance medical care that was often the result of job-related injuries and chronic illnesses. Employers paid for both hospital and medical care under the Blue Cross Blue Shield system. Thus, the story of the origins of private health insurance in the United States is also the story of the conception and growth of contemporary employer-paid health insurance.

PRIMARY SOURCE

PRIVATE HEALTH INSURANCE ORIGINATES WITH BLUE CROSS AND BLUE SHIELD

See primary source image.

SIGNIFICANCE

The original Blue Cross and Blue Shield plans were not-for-profit organizations that were required to offer patients free choice of physicians and hospitals. They secured state legislation exempting them from carrying insurance reserves such as were required of commercial insurance companies. Instead, hospitals agreed to provide care for patients when the plans lacked funds for reimbursement. Freedom from burdensome reserve requirements helped to keep costs down and further contributed to growing health insurance sales.

The Blue Cross and Blue Shield plans grew rapidly, insuring over 20 million Americans by 1940. By that time, the commercial insurance companies began to show interest in health insurance once the "Blues" had pioneered the concept, defined the "medical necessity" of treatments, and established the financial viability of employer-group health coverage. Commercial coverage helped fuel further rapid growth of health insurance. By 1950, both commercial and Blue Cross Blue Shield plans had enrolled more than 140 million members.

The U.S. employer-based health insurance system is characterized by a multitude of optional policy features, some of which can be elected by an employer in behalf of its entire insured group and others which are elected by individual employees. Employees generally pay extra for optional coverage, and this can increase their contributions to thirty percent or more of the total insurance premium. The employees' contributions are deducted from their paychecks.

One of the enduring controversies regarding group health insurance involves community rating versus experience rating. Under community rating, the cost of insuring sick people is spread across a large population of mostly healthy people, as in a state. Under experience rating, the cost of a policy depends on the health-insurance-claims experience of people in a defined group, such as a company. Companies often question why they should subsidize the health care costs of people in the larger community that may be older and sicker than their employees. This reluctance to accept cost spreading has resulted in a breakdown of community rating so that older, sicker groups pay higher premiums than younger, healthier groups for the same benefits. One consequence of experience rating is that the health experience (and the insurance premium) for any particular group fluctuates over time around an average cost closely related to its average age (group experience "regresses to the mean"). There is constant "churning" of health plan membership as companies get good rates based on several years of often fortuitously low health care insurance claims, then get "blown off the books" by insurance underwriters as their claims inevitably get worse in succeeding years. Actuarial analysis shows that three good years during which members enjoy better than average health tend to be followed by three bad years during which the group experiences more illness claims and worse than average health. This is the so-called health insurance "underwriting cycle." This churning in membership based on short-term experience has, in turn, led to an undervaluing of illness prevention in the U.S. There is less incentive to encourage healthy lifestyles among plan members, if they are going to be with another plan in less than five years. Churning also results in more employers dropping employee medical coverage as they are faced with premium increases that they can't afford; hence, the large number of employed, uninsured persons in the United States.

In the 1960s, it became clear that employer-based insurance left many retired and elderly people without health coverage at a time when they require more health services. Medicare, public health care financing for people over sixty-five, was established in 1965. Increasingly critical prescription drug coverage will be added to Medicare in 2006. Also, the U.S. has a substantial population of mostly poor women and their children who are not employed and cannot participate in an employer plan. In 1966 Congress passed the Medicaid law establishing a state-federal partnership to provide health care financing for persons in poverty without access to other health care coverage. These two programs provided a health care "safety net" that addressed two major weaknesses in the employment-based health insurance system, and pre-empted system critics who advocated a national health insurance program similar to those found in other industrialized countries.

The evolution of the U.S. public-private health insurance system has been incremental in that glaring gaps in coverage have been addressed with public insurance programs such as Medicare and Medicaid. Expenditures on these public programs now account for about one-third of all U.S. health care expenditures. The cost of health care for both public and private health insurance programs is growing at a rate that has outpaced general inflation in the U.S. economy for decades. Health care comprises an ever-increasing proportion of the nation's total economic output. It currently is about fifteen percent of the total U.S. economic output—the highest of any of the Organization for Economic Cooperation and Development (OECD) industrialized countries. In spite of this enormous expenditure, about 40 million Americans do not have health insurance and receive uncompensated care on an emergency basis. The U.S. also has the highest rate of health care cost increases among these industrialized nations. These trends are driven by rapidly advancing medical technology, the insulation of consumers from the true costs of health care by their insurance plans, and, according to some economists and insurance executives, a lack of cost-effectiveness in U.S. health care.

The remarkable and unparalleled growth of private health insurance coverage in the U.S. presents a mixture of advantages and problems. The U.S. system continues to foster the highest degree of innovation in medical technology and pharmaceutical treatment as well as in financing mechanisms. Recent examples of such financing schemes include managed health care plans in which payers intervene in medical treatment with guidelines (usually devised by medical societies), restrictions, and incentives for certain patterns of care. Another innovation is the so-called consumer-driven plan in which patients encounter the true costs of healthcare as they deduct reimbursements to health care providers from a tax-exempt health care savings account (HSA). Health care expenditures in the U.S. are not subject to a national budget that can be cut back, and individuals have discretion regarding how much they can spend on health care, and when and where they can get services.

Some of the problems with U.S. health care and health care financing include the huge population of uninsured persons, the lack of incentives for illness prevention, and the absence of interest in applying cost-effectiveness analysis to health care interventions. Both public and private payers often pay significantly higher prices for new treatments that are only incrementally effective for relatively narrow patient groups. These treatments often have been prescribed instead of older treatments that are equally effective for most patients. For example, a patient with transient headache pain might be prescribed a cox-2 inhibitor drug, such as Vioxx, that costs dollars per dose, when an aspirin, costing pennies per dose, might be equally effective.

The lack of cost-effectiveness accountability in U.S. health care arises because both public and private health insurance programs have been effectively prevented from applying cost-effectiveness criteria to the coverage of medical products and services by consumer and taxpayer pressure on businesses and the government. The risk of high health care inflation appears to be greater under a private system than under a public system because prices for health care products and services under government-run systems are usually severely constrained. On the other hand, such constraints appear to reduce investment in research and development for medical technology, as witnessed by the fact that most pharmaceutical research and development activity now takes place in the United States.

After more than eighty years of private, largely employer-based U.S. health insurance, companies are finding that funding health care puts them at a disadvantage in global economic competition. They are shifting an ever larger proportion of the cost of care and insurance premiums to employees, who are paying more either out-of-pocket at the pharmacy or clinic or out of their paychecks. Health economists, such as Uve Reinhardt of Princeton, maintain that employees have been paying for health care all along in reduced long-term income growth. The U.S. now appears to be moving toward a health care system in which consumers—perhaps with employer guidance and infrastructure for negotiating with providers and increasing protective regulation from government—will become the primary payers for their own care.

FURTHER RESOURCES

Books

Dranove, David. The EconomicEvolution of American Health Care. Princeton: Princeton University Press, 2000.

Kleinke, J. D. Oxymorons: The Myth of a U.S. Health Care System. San Francisco: Jossey-Bass, 2001.

Periodicals

Thomasson, Melissa A. "From Sicknessto Health: The Twentieth-Century Development of U.S. Health Insurance." Explorationsin Economic History 39 (July 2002): 233-253.

Web sites

Blue Cross Blue Shield Association. "History of Blue Cross® Blue Shield®." 〈http://www.bcbs.com/history/bluebeginnings.html〉 (accessed October 20, 2005.)