Private Health Insurance
Today health insurance has become a most needed resource in American society. With the rates of health care costs rapidly increasing, health care is becoming harder to afford without insurance. Currently, the majority of Americans have some sort of health coverage whether it be from private or publicly funded insurance plans. The emergence of health insurance has revolutionized and completely reshaped the way health care is paid for in this country in less than a century. This shift started with private health insurance, and continues today with private insurer plans being the largest payers of health care, accounting for 34 percent of the nation’s health care dollar in 2000 (HCFA 2002).
History of Third Party Payment and Private Insurance
Community Rated Insurance
The entity of health insurance did not come to the forefront in the United States until around the 1930s. Before this era individuals were required to pay out of there own pockets for their medical expenses. For those who had difficulty paying, there were some forms of aid such as government subsidies, charity from religious sources, and charity from doctors themselves. Charity from doctors was the largest source of charity at this time.
The first health insurance plans started around the time of the Great Depression. During this time many individuals were unable to pay for their medical bills. They therefore found it hard to seek medical services, and hospitals and doctors were also suffering the loss of revenues. To quell this situation, hospitals began to offer insurance programs later to be known as Blue Cross. The programs helped patients by allowing them to pay fixed amount periodically for certain amounts of services, although they could not afford to pay the total cost of their medical bills. The programs were also put in place to benefit hospitals by helping them to restore loss revenues.
While these programs started with individual hospitals, they grew to become community wide plans, called hospital service plans, including many hospitals within one plan. These plans had the backing of the American Hospital Association (AHA) and federal and state governments. In the beginning the sale of hospital services was not considered insurance, so the plans were exempt from government regulations on insurance companies. But states quickly passed legislation to formalize these plans, making them not-for profit-organization so that they would also be exempt from the taxes and other requirements of commercial insurance companies.
Along with Blue Cross developed Blue Shield. Instead of a plan including participating hospitals, Blue Shield providers were physicians or groups of physicians. There backing came from the American Medical Association (AMA). There are now 63 Blue Cross organizations and 65 Blue Shield organizations across the United States, 50 of which are joint Blue Cross/Blue Shield organizations (Gapenski 1993). These organization serve different regions across the country and are all linked to one another through the Blue Cross and Blue Shield Association. The number of members in Blue Cross and Blue Shield plans grew rapidly from the time of its inception. In 1938, 1.4 million Americans were members of Blue Cross/Blue Shield. By 1951 the membership had increased to 37.4 million (Moreno 1991). They still remain one of the largest health insurers in the nation (1993).
The organizations began as community-rated plans, meaning that hospitals and physicians charged the same fixed amount for services for each individual in the community who wanted to be a part of the plan regardless of income, age, sex, or health status. But because of rising inflation rates and cost of care, many Blue Cross and Blue Shield plans have moved away from the charge-based or cost-based methods of payment to prospective payment systems. These types of payment systems will be discussed later in the chapter.
Commercial Insurance Plans
Closely following the community-rated plans of Blue Cross and Blue Shield were the formation of commercial health insurance companies. These groups were formed independently of hospitals and physicians, and were solely formed for the purpose of selling health insurance. These companies were organized by investors as either stock or mutual companies. Stock companies were owned by stockholders who bore responsibility for financial risk. Mutual companies were managed by a board of directors elected by the company’s policyholders. Unlike Blue Cross and Blue Shield, these companies were for-profit organizations with the ability to raise capital, and were therefore taxable entities (Gapenski 1993).
Similar to community-rated plans, commercial insurers offered group policies to employee programs, professional associations, and labor unions. Group policies were important at this time during the 1940’s and 1950’s to attract workers to companies. Both employers and employees alike were attracted to the group plans. Employers were able to deduct their contribution from taxes. Employees were also able to deduct their premiums from taxes as well as having the added benefit of health insurance.
Group plans were popular and advantageous at this time for many reasons. One reason was that because many individuals were insured under one contract the administrative costs were kept low. This kept premium rates low. Workers were happy because employers usually paid most or all of the premium, and in exchange they were given the benefit of having health insurance. Also, eligibility in group plans does not depend on individual members, but on the overall health of the group. Therefore, no one within the group can be denied coverage. This works well in large companies where there are enough healthy employees to offset the sicker ones. In small companies, the poor health of a few individuals may adversely affect more healthy individuals. But in general there are usually good outcomes. Also important for members is that their coverage cannot be canceled unless they leave the group or unless the plan itself is canceled by the contract holder (usually an employer) or the insurance company. Because of these benefits, employment based insurance plans have remained the largest source of private insurance coverage for Americans.
Commercial plans set the standard of traditional indemnity plans where members had an unlimited choice of providers. Under this system providers were reimbursed for each service they provided (IHA 2002).
Self insurance is another form of health insurance used by large groups or companies. Many times employers of large companies will set aside funds specifically to cover the costs of health care for employees. The structure of self insurance takes three forms. The first is where an employer pays a community-rated or commercial insurance company to administer health care services. While the insurance company provides the health care coverage, the employer is the party that bears all associated risks. In the second form employers bypass third party payers and bargain with hospitals and physicians themselves for discounted coverage for a group of employees. In the third form employers set up their own health services for employees with the hope that they can provide less expensive care with the same quality (Gapenski 1993). This last system of self insurance is run much like a managed care organization.
The Concept of Private Health Insurance
The purpose of health insurance, as with any type of insurance, is to reduce the risk of loss associated with the occurrence of certain events, namely sickness or injury. This is accomplished by shifting the financial risk on to insurance companies. The structure and payment system of insurance companies are based on the probability of these events occurring. Because most individuals would not be able to pay for the total cost of medical services on their own, insurance allows them to pay a fraction of the amount of the presumed risk with the thought that if enough people buy into the insurance policy they will have enough capital to bear the cost of the risk in the event of sickness or injury actually occurring. This works on the principle of the law of large numbers, assuming that the probability is small enough that only a fraction of the total number of policyholders would get sick or injured. Since all policy holders are invested in the plan, there would be enough money to cover the small amount of individuals within the plan who do fall ill. The premiums paid to the insurance company would provide reserves for actual claims of illness (Gapenski 1993).
This concept of insurance leads to four basic characteristics. They are pooling of losses, payment only for random losses, risk transfer and indemnification (Gapenski 1993). Pooling of losses implies that the losses are spread across a large group so that actual loss resulting from one individual is only realized as an average loss by all individuals that is much smaller than the actual loss. Payment for random losses means that payments are made by insurance companies only when losses occur, such as illness or sickness. It is based on the principle that the loss is unforeseen, unexpected, and brought on by chance. Risk transfer refers to the risk being transferred from the individual to the insurance company. Indemnification is where the insured individual is reimbursed for losses that occur either by paying the insured person so that they can in turn pay the health care provider for health expenses incurred, or by directly paying the health care provider for expenses incurred. All of these characteristics imply that the occurrence of the need for medical expenses happens as a circumstance of chance, and not by the personal choice of consuming health services.
Due to the nature of health care, health insurance is subject to adverse selection. This adverse selection is that those who are more likely to buy into insurance plans are those who are more likely to have claims, and those who are less likely to buy into insurance plans are less likely to have claims (Gapenski 1993). Without a balance, too many sick people in an insurance plan could lead to a larger amount of claims than can be covered by the insurance premiums. The risk of loss would be increased because the members of the plan would be paying less in premiums than their expected health care costs. This defeats the purpose of insurance and does not allow the insurer to pay for all claims and keep the company afloat.
To correct this problem some insurer increase premiums. But many times the increase in premiums still does not cover the amount of expenses to be paid. If insurers raise premiums too much members may leave the plan because of the high cost, and it may deter new members from joining. To better solve the problem of adverse selection many insurance companies have turned to the practice of medical underwriting. This is a process in which insurers select which individuals they will allow into their plans (Insure.com 2002). The insurers select individuals who will most likely stay healthy, to the exclusion of the sick – cherry picking, as one AMA writer calls it (Lowden 2000). Through underwriting insurers exclude certain individuals on the basis of certain risk factors such as health status, work environment, living environment, and most importantly pre-existing conditions. A pre-existing condition is any medical conditions that has been diagnosed or treated before an individual becomes a member of an insurance plan (HIPAA Complete 2002). These individuals were seen as a greater risk for insurers and were either excluded from the plan altogether or allowed into to the plan at higher premium rates.
While medical underwriting may ease the financial burden for insurance companies, they are discriminatory towards certain individuals. Even more crucial is that they are discriminatory towards the individuals that need health insurance the most. To deter private insurers from exclusionary underwriting the federal government has passed acts into legislation that require these people to be offered coverage. The first is the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985. Part of this legislation allowed for former employees, their spouses and dependents to continue to be covered under their former employment health plan for a period of up to eighteen months after leaving employment under certain circumstances (Insure.com 2002). This provision made it easier for former employees with pre-existing conditions because they did not have to worry about the hardship of medical underwriting in from changing jobs or insurance policies. The second act, the Health Insurance Portability and Accountability Act (HIPAA) of 1996, specifically aids individuals with pre-existing conditions. Under this act, new employees with pre-existing conditions could not be denied health insurance from a new employment group plan as long as the condition was covered under the employee’s former insurance plan. Even if the condition was not covered, the insurer is still obligated to allow the employee in the plan without covering the condition. But after 12 months the insurer was also required to cover the condition. Federal law also prohibited group plans from practicing medical underwriting (Insure.com 2002).
Methods of Payment for Private Insurance
The traditional form of payment for health insurance is a retrospective method. In this method providers are reimbursed for the services they provide after they have been provided. The term most often used to describe this type of payment is fee-for-service (IHA 2002). In this system health providers set the price for the services they provide and insurers and patients must comply with payments. Providers are paid for ownership of the medical equipment, and for performing tests and reading test results. Fee-for-service plans run the risk of over admissions, testing, and referrals. It is inflationary because it stimulates the overprovision of care that is sometimes unnecessary and inappropriate (Moreno 1991). Providers have an incentive to do more because the more services they provide the more they are compensated. Patients have the incentive to consume more because do not have to bear the financial risk. Because of the lack of provider/patient matters the provider is less likely to have a concern with charging more because the patient does not have to pay. This leads to no market discipline where providers can charge whatever they want for services without any consequences to themselves (Moreno 1991).
Fee-for-service payment became quite expensive for insurers, so they worked out plans with providers to lessen the cost of claims. The fee-for-service method was still used, but insurers used fee schedules to reduce the burden. Fee schedules allowed insurers to reimburse providers on a predetermined schedule. Whatever the insurer did not pay within that time is what the patient owed. The thought was that patients would feel the brunt of this and would reduce their consumption (Gapenski 1993). Although fee schedules slightly reduced providers’ reimbursements, many of them preferred it in exchange for a larger volume of patients guaranteed by the insurer.
Along with fee schedules insurers adopted a price setting practice called UCR (usual, customary, and reasonable). This practice set a maximum price for services over which providers could not charge (Insure.com 2002). This practice was adopted by virtually all Blue Shield plans and many indemnity plans. UCR prices were set on an average of what the services were worth and what physicians usually charged for them. To define what a service a list of common procedural services (CPT) were adopted by the AMA. The first list was adopted in 1966 and is now updated annually (Moreno 1991).
Fee schedules and UCR’s allowed insurers to control spending somewhat, but they still carried a risk of inflation because providers were still able to raise prices.
Prospective payment is a system where the rates paid by insurers are determined in advance (Gapenski 1993). This form of payment is known as capitation. Under capitation providers agree to be paid a fixed amount per person (usually per year) in exchange for providing a certain set of services. The provider receives the same payment know matter how little or how much the services are used (IHA 2002). In this situation the insurer shares the financial risk with the provider, and the provider no longer has the incentive to over utilize unnecessary services because he will not be paid for them. Capitation attempts to correct the abuses of fee-for-service payment by cutting down on unnecessary admission, tests, and procedures.
Capitation can be carried out in numerous ways. One method is a per diagnosis basis, where the provider is paid a fixed rate based on the patient’s diagnosis. The most common usage of this method is the diagnosis-related groups (DRG) system instituted by Medicare and adopted by many private insurance companies (for more on DRGs, Medicare, and Medicaid see chapter on public health insurance). A second method of capitation is a per diem basis. This is where a provider is paid a fixed amount for each day a service is provided no matter what the service is. A third method of capitation is a per admission basis where the provider is paid a fixed amount for each admission, regardless of the services provided or the length of stay (Gapenski 1993). These capitation methods increasingly shift more risk onto the provider. Insurers may use one or all of these methods in any combination.
Some criticism of capitation is that it may provoke providers to underserve their patients for their own financial gain, because now the less they use the more they will gain financially. To solve this problem many insurers using capitation have instituted quality assurance programs into their plans. But despite the criticisms of capitation, it is the most rapidly growing method of payment among private insurers because of its efficiency (Moreno 1991). The major users of the capitation system are health maintenance organizations (HMOs).
Moral Hazard of Insurance and the Emergence of Managed Care
As discussed earlier, certain structures of insurance can lead to unnecessary utilization of resources. This is known as the moral hazard of insurance where “the mere presence of insurance motivates people to use more, and more costly, health care services than they would if they were paying the entire bill” (Gapenski 1993:79). Traditionally insurers have tried to fix this problem by raising premiums and shifting more cost onto members in ways such as deductibles and co-payments. However, it has not always been enough to keep down the cost of health care. But the recent emergence of managed health care has put its aim at efficiency in health care and reducing unnecessary spending.
Managed care organizations seek to make health care more cost-effective while providing comprehensive care and still assuring quality. They are more focused on preventive health and provide incentives toward this goal. They seek to shift more of the risk onto providers by making them more accountable for their patient’s health outcomes. Traditional managed care plans share the risks with providers by combining insurer and provider into one entity. This is typical a health maintenance organization (HMO).
HMOs were the beginnings of managed care. The first HMO established, and still the largest is the Kaiser Foundation (Bisbee and Vraciu 1980). Under this type of plan the insurer actually provides a comprehensive set of services for enrollees. Patients are assigned a primary care physician from with in the network of providers. Services sought outside of the network are not covered, and patients can only get specialty care through referral from the primary care physician. This reduces the incentive to consume more. Primary care physicians act as gatekeepers to services for patients because they have a dual role to make sure that patients are healthy and to guard the finances of the insurer because the providers’ financial welfare depends on it also. Because of these dual roles the provider has a disincentive to provide more services.
To assure quality and efficiency HMOs practice utilization review. This practice assures quality and efficiency by verifying services for eligibility and appropriateness. There are three types of utilization review: retrospective, concurrent, and prospective. Retrospective review verifies claims after services have been rendered. Concurrent review verifies services to be rendered on a daily basis while a patient is being cared for. This method is used to make sure that the appropriate level of service is being used at each step. Prospective utilization, or pre-certification, is the process of verifying services before they are rendered. This type of utilization review is the most used by managed care organizations and falls in line with their prospective payment system (Aetna 2002).
HMOs have four basic structures (IHA 2002; KFF 2002):
Some HMOs have set provision so that enrollees can seek services out of the network if desired. This is point of service (POS). POS allows an enrollee to seek outside services, but they will have to pay a higher co-payment or a high deductible (IHA 2002). Because HMOs were so successful at efficiency and reducing consumption, other forms of managed care began to arise.
Preferred provider organizations (PPOs) were established in the 1980s (Gapenski 1993). They are a cross between HMOs and traditional health insurance companies. PPOs are similar to HMOs in that they use capitation methods of reimbursement and are focused on quality assurance and efficiency through utilization review. PPOs are similar to traditional insurance plans in that they do not require that enrollees be assigned a primary care physician and there are no gatekeepers. Enrollees are given the choice to select services outside of the network, but incentives to stay within the network are given such as discounted cost.
Conclusion: The Future of Private Insurance
Both HMOs and PPOs are growing rapidly while traditional insurance plans are somewhat declining. Because of their proven efficiency and cost cutting results, and the constant struggle to keep health care expenditures from rising, many traditional insurance plans are adopting managed care methods such as utilization review and capitation (Gapenski 1993). National health care expenditures already expected to account for 14.7% of the gross domestic product for 2002, and its rate of increase seems to have accelerated in the last couple years (HCFA 2002). To slow this increase it would not be surprising to see the majority of private health insurers looking and acting like managed care organizations in the near future.