Healthcare History: The Emergence of Health Insurance

The following is composed largly of excerpts from Paul Starr's seminal book, The Social Transformation of American Medicine.

The conventional account of the history of health insurance places the emergence of Blue Cross in Dallas in late 1929, the start of the depression, when Baylor University Hospital agreed to provide 1,500 school teachers up to twenty-one days of hospital care a year for $6 a person. Soon, Baylor extended the arrangement to other groups including several thousand people. Others followed this example with the general rule that 1/3 of contributions were held for expenses and profits.

These early arrangements were all direct-service plans, set up by individual hospitals in competition with each other.

As the depression endured, people couldn't afford to go to the hospital anymore. In The Crisis in Hospital Finance, Michael Davis and C. Rufus Rorem warned that hospitals could not continue to rely on patients to pay all their bills when they were hospitalized. Thus, the costs had to be budgeted in advance through insurance: "The life of voluntary hospitals is threatened because of the inevitability and unevenness of this main source of income," some wrote at the time, referring to payments by patients.

In February 1932, the American Hospital Association approved hospital insurance as a "practicable solution" to the problem of distributing the costs of hospital care, and they adopted certain guiding principles in concordance with this ruling:

(1) The plans were to be non-profit, to emphasize the public welfare, and to limit themselves to dignified promotion;

(2) They were only to cover hospital charges, thereby not infringing on the domain of private practicitioners. Single hospital plans like the ones growing in Dallas might well have brought more instability to the hospital industry because of the comparison they would have promoted. But another response was already developing.

(3) Most importantly, they were to provide "free choice" of physician and hospital, a requirement that ruled out the single-hospital plan.

In July 1932, the Community Hospitals of Sacremento jointly offered hospital service contracts to employed persons, and in January of the following year, hospitals in Essex county, New Jersey, authorized a similar joint plan. Hospitals were banding together.

Unlike insurance companies, these plans were organized with hardly any starting capital. This was possible because of "hospital underwriting." Instead of backing the promise of service with financial reserves, the plan had its member hospitals agree to provide service regardless of the remuneration they would receive.

Law required that a majority of the directors of these plans be administrators or trustees of the hospitals that contracted to provide the services. The hospitals were able to gain this authority since they were underwring the plans.

The question of hospital control would not have been so important, except for the drift from the competitive, single-hospital to community-wide plans that effectively became monopolies in hospital prepayment.

The AHA's chief expert on group hospitalization recalled in 1944 that the early single-hospital plans had resulted in "competition among the hospitals, and interference with the subscribers' freedom of choice and the physicians' prerogatives in the care of private patients."

It is unclear, however, why subscribers would have had less choice if they could choose from a variety of plans offered by hopitals in their community. The AHA did not encourage community-wide plans in addition to single-hospital plans, but instead of them. In this respect it denied consumers the choice of contracting with a single'hospital plan and possibly securing a more favorable price.

In 1938, an AHA committee adopted a revised set of principles for these plans, specifying that there be no competition among them. Each was to have its own defined territory. The AHA now also stipulated that plans be supervised by the states through insurance or other departments, that they provide reserves of service rather than cash, and that they offer service benefits rather than indemnities.

By 1939, 25 states had passed special enabling acts for hospital service plans, declaring them charitable and exepmt from taxes.

Blue Cross had been started against the advice of professionals in the insurance industry. Actuaries did not believe adequate statistics were available to predict losses with confidence. Moreover, service benefits violated the concept of limited liability and the rule that insurance should never increase the hazard. In some respects, service contracts were like blank checks for subscribers, physicians, and hospitals; they were open-ended and did not limit the plans' dollar liabilities. Their "first-day, first-dollar" coverage would encourage hospitalization.

It didn't take long for competitors to follow suit, and by 1940, 9.7 million people were covered by Blue Cross or one of their competitors.