A brief history of how the American healthcare system became high cost and low performance

In two separate but connected articles posted on the Mises Institute website, Part 1 covering the pre-World War II construct of American healthcare and Part 2 covering the explosion in healthcare costs and our current system development post World War II, Dr. Michael Accad, a Cardiologist with an impressive resume and who has a tremendously insightful blog, provides a remarkable yet succinct overview of how we got to where we are today, which can be briefly described as a costly and underperforming health system.

In just a few minutes, the reader will witness the 100+ year descent into the 7th layer of hell that is our healthcare system and all the errors and paternalistic hubris that got us there. Begin with the status of healthcare in the 19th century, which while far from ideal (this is the era when bloodletting, blistering, and toxic purgatives were common, after all), was beginning to witness the emergence of competitive and innovative medical reforms under a scientific and competitive basis under the guide of the free market invisible hand. For example, germ theory and surgical advancements, and the formation of high-performing health systems such as Mayo Clinic that practiced care on these scientific foundations, were beginning to blossom in the late 19th century without the meddling hand of government agencies and regulations that are prevalent today. But then everything changed when in the early 1900s, a sensational report on the inadequacies of the health system penned by Abraham Flexner resulted in reforms in more onerous physician licensing and health education that remain largely intact to the modern-day. The offshoot was a tremendous narrowing of diversity in medical approaches and education models and medical practices. Everything outside of the Flexner dogma was ostracized and shunned. The challenge with this paternalistic approach is that licensing led to self-serving restrictions on the supply of physicians, leading to spiked costs.

Part 2 of the series covers the evolution of the American health system into what we know today. With increased costs came a decrease in demand. With excess hospital and physician capacity, leaders in healthcare began crafting strategies to increase collective payment models that would blunt the direct cost impact on consumers and thereby increase demand in line with existing capacity. While a European national health system seemed politically out of the question, pilot models in which employees of a Dallas school system were part of a collective payment system seemed to offer the best model to emulate more broadly in order to bring up hospital service demand as well as mitigate adverse selection of the sickest patients opting into insurance plans. Intuitively, people who are able to work are typically healthier than the average American. Legislation promoting insurance plans duly followed, with favorable reserve requirements for Blue Cross and Blue Shield Programs compared to other types of commercial insurance as well as tax exemptions for employers who offered health insurance coverage through the 1942 Stabilization Act. My own editorializing is that the reader should bear in mind that this legislation was a compounding error in the sense that it was meant to address a challenge with employers being able to compete for employees given pricing and wage controls that were persistent in that era. Allowing employers to de facto increase their wages by offering health plans was a backdoor sop allowing them to more effectively compete for labor. The unintended consequences that we are still living with today is that we are collectively highly dependent upon employers for health coverage, which has its own perverse effects of holding people hostage to jobs as well as decreasing our direct take-home pay. The more immediate impact of this in the mid-century was a rapid increase in medical utilization and price inflation. I wish a magic time machine would allow me to just go remove the insidious price and wage controls in the first place.

Dr. Accad focuses heavily on the paternalism of the system that drove us inexorably towards the vicious cycle conclusion that government must take an active role in providing insurance, at great risk and ignorance of the ensuing moral hazards of over-using healthcare services that such an approach entails, which further leads to a whack a mole approach of controlling costs. Better to have not created the holes and brought in the moles in the first place, but I digress. Through a Question and Answer method, Dr. Accad elaborates on two aspects of moral hazard and how this most important of economic concepts impact health care:

Q:  What are the two aspects of moral hazard?

A: The first one, which matches the negative connotation of the term, is the aspect imported from other insurance settings. For example, in the case of car insurance, the term moral hazard refers to the fact that someone with car insurance might drive less carefully than someone without coverage. In a way, that person may be “taking advantage” of the insurance company.

In health care, that aspect of moral hazard probably exists, but may not be very important. For example, it’s conceivable that people who have insurance are more likely to engage in more dangerous sports activity. But this kind of moral hazard can probably be accounted for by the insurer and be factored into the actuarial analysis to determine premium prices.

The other aspect of moral hazard stems from the fact that every single medical encounter or medical act can be said to be ordered toward the preservation of life or toward the well-being of the person. This by itself presents a strong incentive to use medical services, and the behavior should not have the same negative connotation as in the first aspect of moral hazard. In fact, economist John Nyman has argued that the behavior by which insured people would use more health care is a social good.

The bottom line is that one does not need to be sick to utilize medical services and that all that is needed is a plausible argument that if a medical action is taken, life may be prolonged or enhanced. Such plausible arguments are not hard to come by, especially in a health care system where doctors and hospitals are largely paid on a fee-for-service basis. There is no objective limit on what can be considered “desirable care,” and if cost is not a consideration, more medical actions will be taken.

Of course, when consumers are shielded from direct costs, there is little to stop inflation. Insurance premium inflation has consistently outpaced general inflation since the 1950s. Stop and think about how remarkable that factoid is. Dr. Accad addresses this as well, and I love the comparison of health insurance to a harmful drug:

Q: Didn’t the increasing cost of insurance hurt employers?

A: To the extent that it did, there was not much employers could do about it. With rising medical prices, the need to have health insurance would become more and more acute. Employee discontent would have been too great to abandon health insurance as a benefit. Executives themselves also benefited from the group rate, so the idea that health insurance should be abandoned could not be entertained seriously.

Q: People were hooked!

A: Health insurance is a seriously addictive and harmful social drug.

Once medical price inflation occurs for those who are covered, those who are not covered begin to get priced out of the market. During those times, it tended to be the poor, the aged, and unemployed who were left in the lurch, and that brings us to Medicare and Medicaid:

Q:  How was the situation addressed?

A: With the enactment of Medicare and Medicaid in 1965. The government provided generous health insurance benefits to the most politically influential class, the elderly, which also happens to be the class whose needs for medical care are naturally the highest.

The terms of Medicare insurance were also very generous to physicians and hospitals since, to secure their cooperation, the government decided to pay them their “usual and customary rate,” which means that, for a time, the government had no way of controlling costs.

Q: I can see things spiraling out of control…

A:  As a matter of fact, once Medicare was introduced, medical prices became completely “unhinged.” Within a few years, Medicare expenditures were quadruple what had been anticipated.

The demand for medical services was so high there was an acute shortage of doctors. Immigration laws were adjusted to allow a rapid influx of physicians from abroad. There was a boom in hospital construction. Incredible facilities and health care complexes were built.

Naturally, with skyrocketing medical prices, insurance premiums had to increase correspondingly. This began to really affect employers.

The rest of Dr. Accad’s journey through the American health system history concludes with the modern-day challenges to restrain the predictable cost increases that ensued with Medicare – from the Managed Care Organizations that were designed in the 1970s to the various pay for performance schemes, Accountable Care Organizations, and shifts from fee for service that we see today. Some of these are likely steps in the right direction, and it is certainly better to pay physicians based upon outcomes and quality rather than volume of services. That being said, with all of the recent mandates and focus on payments for an entire episode of care that has and will incent mergers and consolidation, I am not sure the incentives will truly be great for newly minted local monopolies to increase quality and pass on cost savings to consumers.

It would be far more effective to implement policies that end onerous licensing and task performance restrictions (i.e. by allowing nurses to perform tasks they are perfectly capable of), end supply side restrictions (it is near impossible to open a new hospital in an area due to hospital political lobbying and political connections at the local and state level), end reliance on insurance that covers everything, which obfuscates health care prices, provide individuals with the same tax advantages that employers receive for health service coverage, shift employer based coverage to portable and widely usable health savings accounts, and replace health insurance subsidization for the poor with directly funded health savings accounts similar those enjoyed by their better off peers. Such a model would drive greater innovation, better customer service, and more transparency around outcomes and costs. All of these combined would tame cost inflation while at the same time increasing health outcomes.



One thought on “A brief history of how the American healthcare system became high cost and low performance

  1. Pingback: Reasons to care about our American health care crisis – 300 million personal and 3 trillion dollars of them – The Gymnasium

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