Paying for Employee Health Care: It Could Make You Sick

Following a period of relative quiescence, the American health care system is once again a subject of national attention and contention, as the problems of cost and access have resurfaced. We spend more on health care, both absolutely and as a percentage of national income, than every other nation, yet our people are no healthier than other advanced countries’. Americans, moreover, are the least satisfied with their medical care system and are very concerned about losing their insurance coverage.

Although the rate of overall inflation has dipped to near record lows, health care prices are skyrocketing once more. At the same time, the number of Americans without health insurance is mounting. The two problems, of course, are interrelated.

In a new report, the National Academy of Sciences (NAS) contends that our health care delivery system is in crisis and concludes that the system is “incapable of meeting the present, let alone the future, needs of the American public.” It urges immediate action to test possible solutions, including universal insurance coverage.

In this issue of IRConcepts, we look at the forces operating in the health care system and examine the subject of health care from both an employer and a national perspective. The message will not be a hopeful one—any realistic appraisal of the problems involved leads to a dismal prognosis of our country’s economic and political capacity to deal with them. We conclude that the NAS study’s recommendation to test universal insurance coverage is the most hopeful solution available. Even so, optimism about the efficacy of that solution is dampened after looking at Exhibit 1, which shows the annual percentage change in private health spending per capita and illustrates that each time a new health care model was put in place—from Medicare and Medicaid in the 1960s to the managed care approach of the 1990s—spending initially went down dramatically. But then, just as dramatically, it zoomed back up.

Despite this depressing history, one cannot simply give up on trying to make our health care system both excellent and affordable and fund it in a way that fairly shares the burden among employers, employees, and government. In a way, excellence is the easy part. Health care in the U.S. is an issue because of cost and access, not competence. Indeed, Americans today have become healthier and live longer than prior generations. Rising incomes, improvements in nutrition, housing, and education, and better life styles have contributed to this achievement, but medical advances, s­uch as miracle drugs that reduce the dangers from pneumonia and other infectious diseases, have been crucial. At the other end of the age span, we have drastically reduced infant mortality and virtually eliminated many diseases that plagued children, from diphtheria to polio.

But we cannot rest on our laurels, for there is still a good deal to be done. Health care is an investment that brings high returns, not only in longer life, but for society as well, since healthier people are more productive. That said, before discussing what needs to be done to increase returns on that investment, let’s examine where we are today and how we got there.

Historically, the key person in health care was the physician, the “family doctor,” who was a general practitioner and rarely sent patients on to specialists. Overwhelmingly, physicians were in private practice, and for many years, county medical associations prohibited members from engaging in group practice. Like other independent entrepreneurs (e.g., lawyers, plumbers) they charged fees based on the services provided. They often deviated from fee schedules according to patients’ ability to pay. In effect, the physician played the role of a progressive tax collector, redistributing income from higher to lower income families. Today, the profession has changed radically. Most physicians have specialized. Those still in private practice are also affiliated with managed care groups and have adopted standardized rates.

The second major part of the health care industry is the hospital, the center for critical care. The dominant type, still 58 percent of the total of 5,000, is the private non-profit hospital, a community-based voluntary organization, often affiliated with a religious group. Some voluntary hospitals, along with universities, operate medical schools at which the nation’s physicians are trained. Today, 27.5 percent of hospitals are government-operated: city hospitals, to which the poor turn for care; state hospitals; and at the federal level, the host of Veterans’ Administration facilities.

Of more recent vintage are private, for-profit hospitals owned by corporations, many of which are parts of national chains. Private hospitals account for 14.5 percent of the total. There also are a myriad of diagnostic services and laboratories providing everything from X-rays and blood test analyses to the latest high technology medical testing and treatment.

The number of long-term care providers and nursing homes has expanded with the growth in the aged population. Of the 17,000 long-term care facilities, 65 percent are for-profit institutions, 28 percent private nonprofits, and 7 percent government-run. Most of them cater to the aged. Some are hospital affiliates, but most are part of corporate chains that dominate the industry. Finally, there are home health care agencies, public and private, that send visiting nurses, physical therapists, and other professionals to individuals’ homes to help them cope with their disabilities and thus avoid having to be institutionalized.

Payments to the health care industry have always derived from a combination of sources, ranging from the individual to governments, communities, religious and charitable organizations, and third-party payers such as insurance companies—who, in turn, are increasingly funded by employers. With the advent of private insurance for health care, and then governmental Medicare and Medicaid, the entire financial situation changed and the patient is rarely the direct source of payment to providers. It is informative to explore how we have gotten to this point.

Before medical insurance became widely available, illness could be a double blow to a family; if a family breadwinner got sick, medical expenses were incurred just as the family income was cut off. After family savings were depleted and ability to borrow from friends and relatives exhausted, there was only private charity to be sought.

A family faced dire financial problems if hospitalization was required. While the poor might be treated in charitable wards of voluntary hospitals or in public hospitals, those above the poverty level—workers and middle-class families who did not want or could not qualify for free care—were hard hit economically when illness required a hospital stay. This became even truer during the Great Depression. The voluntary hospitals themselves recognized this problem and in 1933 began to organize nonprofit hospital service plans known as Blue Cross. Blue Cross applied the principle, on a group basis, of prepaid insurance to meet the cost of hospital care.

As demands for governmental health insurance unfolded, the American Medical Association began in 1945 to advance its own system of prepaid insurance for physicians’ services, known as Blue Shield. Private insurance companies, which had been offering health insurance largely to cover the costs of lost wages, began to sell policies to cover medical expenses. But they were plagued by adverse selection—the people who purchased medical insurance were those most likely to need care, while the healthy refrained from doing so. And so premiums were high, and private insurance did not spread widely.

While other nations began turning to public health insurance, there was strong opposition to it in the United States. Private carriers objected to government competition. Political conservatives saw it as an unwarranted expansion of government into economic affairs. The American Medical Association perceived it as a threat to doctors’ professional standing and income and, when faced with a move to include health insurance in the original Social Security Act of 1935, quickly counteracted it. In 1949, the Truman Administration proposed federal health insurance, but it, too, was defeated. That defeat is considered by many to be the turning point after which the nation moved to a system of (incomplete) job-based private coverage. (1)

During World War II, fringe benefits were excluded from wage controls, prompting unions to use their collective bargaining power to demand employer-paid health insurance. This was made possible by the existence of private insurance plans and Blue Cross/Blue Shield and by the development of more elaborate prepaid medical insurance programs, such as the Health Insurance Plan of Greater New York and the Kaiser Foundation Health Plan.

After World War II, the pattern was set when health and welfare programs were established through collective bargaining in the automobile and steel industries in the late 1940s and early 1950s. Soon most organized workers became entitled to hospital, medical, and surgical care and weekly cash benefits for periods of incapacity, as well as life and accidental death and dismemberment insurance. Over the years, plans were liberalized. Benefits were raised and paid for longer periods, extended to dependents and the retired, and broadened to include new features, such as optical and dental care.

Health and welfare plans became so popular that they were adopted for nonunion facilities as well, and most active workers were covered by medical insurance that afforded them protection from the economic insecurity caused by illness. Thus, workplace-based private health insurance became the norm. It became the norm, too, for employers to assume the entire cost of this insurance because that cost is tax deductible as a business expense. It should be noted, however, that few seasonal, part-time, or temporary employees are provided health insurance, which can mean that their families also are uninsured.

Health insurance covered most active workers, but not the retired. Older people, whose incomes usually decline in retirement, fall ill more often and more severely than younger workers. Therefore, medical expenses become a much greater proportion of their budgets. But medical insurance was often not available to them because private insurance carriers denied coverage to the elderly as poor risks. Only after demands for government insurance intensified did private carriers set up special plans for the elderly, but with high premium rates.

To address these problems, in 1965, health insurance for the aged (Medicare) was added to Social Security’s existing old age, survivors, and disability insurance, and the payroll tax was raised to cover the additional costs. Medicare Part A, hospitalization, is financed by the payroll tax and covers hospital, skilled nursing facility and hospice stays, and home health care costs. Part B, covering physician, diagnostic, and physical therapy services, plus medical supplies, is financed with monthly premiums paid by the insured ($54 in 2002). There are deductibles and coinsurance payments involved in both Parts A and B.

Title XIX of the 1965 Social Security amendments also provided help to people of all ages who are too poor to pay for medical care (Medicaid). It is financed out of general revenues and provides federal financial assistance to states that offer medical help to low-income groups. Medicaid today pays for 40 percent of all births in the nation and 50 percent of nursing home care.

Under the current private workplace-based system, employers provide health insurance to 160 million people—two-thirds of everyone under age 65. With health care costs escalating, the burden on employers has become onerous. According to a recent survey by Hewitt Associates, Inc., the cost of health benefit plans at large corporations rose 13.7 percent in 2002 and will go up another 15.4 percent in 2003. The average cost per employee will jump from $5,456 to $6,295. Despite some passing of costs to employees, the overwhelming portion of the total of $440 billion is borne by employers. Average employee contributions in 2003 will be 19 percent of their own coverage, up from 17 percent in 2001, and 24 percent for dependent coverage, compared to 21 percent last year. There are a number of forces contributing to the rapid rise of health care costs—industry inflation, new medical technology, rising provider charges, government mandates and regulation, increasing consumer demand, litigation and risk management, and fraud and abuse.

Although today’s overall inflation rate is below 2 percent, the health care industry’s rate is much higher. Overall inflation is dampened by productivity increases, which are more possible when producing goods than services. Productivity in health care, a service industry, rose at a rate of only 0.7 percent from 1995 to 2000, so even if its wages were rising no faster than average, it would have steeper cost increases. Health care is also labor-intensive, with remuneration accounting for more than half its total costs, and it is a growing industry with increasing demand for labor, which also drives up pay. The nurse shortage, for example, has led to sharp increases in salaries. At the same time, unionism and collective bargaining are spreading in health care, further raising labor costs.

New technology, including advanced drugs and medical devices and procedures, pushes up costs and accounts for 22 percent of the total increase, according to a 2002 study disseminated by the American Association of Health Plans (AAHP). Prescription drugs alone account for about one-fifth of total costs, and their prices have been rising 17–18 percent in the last few years. The pharmaceutical industry argues that this figure is misleading since, in many cases, new drug therapies have taken the place of expensive surgery. Certainly, technology relieves suffering and prolongs life, but the new therapies have not reduced overall costs. For example, deaths from heart attacks have declined 20 percent in the past two decades, while the total cost of heart attack treatment has risen by 60 percent.

Americans are avid users of technological advances. Magnetic resonance imaging, coronary bypass surgery, and organ transplantation are much more common here than in other countries. Indeed, there is a tendency for the use of new expensive procedures and drugs, even when they are not necessary. For example, a just completed, large-scale federal study reveals that diuretics—water pills—are superior in treating hypertension than the newer drugs—ACE inhibitors and calcium channel blockers—that cost 10 to 20 times more. Many physicians, however, have stopped prescribing diuretics in favor of new expensive treatments.

The AAHP study shows that a further 18 percent of the total increase in health care costs stems from rising provider prices. Having gained market power, many of them are able not only to pass higher costs on, but also to add to them, as shown in rising profit levels. Some providers always have been relatively well remunerated. U. S. per capita GDP is about 10 to 20 percent higher than in other G7 countries (U.K., Japan, Italy, Germany, France, and Canada), but physician earnings are twice as high. Physician income accounts for one fifth of medical expenditures.

There are hospitals that are in financial difficulties, but others have merged in recent years, and in some metropolitan areas, consolidated hospital systems have virtually eliminated competition. Thus, with rising admissions, they have been able to push up rates beyond any increase in their costs. The Federal Trade Commission has attempted to block some mergers, but has been overridden by the courts; even so, it is pursuing investigations to determine actual and potential anti-competitive effects. Formerly, providers had been willing to share risk with health plans, but most hospitals now refuse risk contracts, opting instead for per-diems or variations of fee-for-service.

Compared to other advanced countries, the United States does not have a heavily regulated health care system, but regulations, with their concomitant paper work, have been growing. Compliance with the privacy requirements of the Health Insurance Portability and Accountability Act has added a new heavy cost, although President Bush has cut back some of the rules (e.g., having to obtain written consent from patients on release of medical information for treatment or paying claims). Federal and state mandates (e.g., physical conditions that must be covered) have spread and there are now 1,500 mandated benefits, ranging from alcoholism to infertility treatment. Regulations and mandates are responsible for 15 percent of rising costs.

Increased demand for health care contributes another 15 percent to the cost rise. Medicare, which augmented demand significantly, spurred a spike in health care costs when it was enacted. Growth in population is a source of increased demand, but aging is even more important, since older people require more medical care: a man aged 45 to 54 spends about twice as much on health care as one 35 to 44, and outlays jump a further 50 percent for those 55 to 64. With the aging of the baby boom generation, the problem will intensify, particularly since the elderly are treated more aggressively in the U.S. than elsewhere. Increased demand is also due to more use of preventive and diagnostic services and the public’s rejection of the tighter strictures of managed care.

The U.S. malpractice system adds to costs without contributing to improvement in medical care. The AAHP study estimates that a growing fear of lawsuits on the part of providers is responsible for another 7 percent of the total national cost rise. There has been a dramatic increase in health care litigation, with class action lawsuits and very large malpractice awards, and, as a result, malpractice insurance premiums have skyrocketed. More importantly, it is alleged that fear of litigation has led physicians, hospitals, and other providers to practice defensive medicine—that is, to conduct diagnostic tests and administer treatments that may not be necessary. (2)

Fraud and abuse, which, with other miscellaneous factors, contribute 5 percent to the total cost increase, are hard to document, but there is evidence of both, in both the private and public sectors. For example, HCA Inc., a huge hospital chain founded by Thomas F. Frist, Jr., the father of the new majority leader in the U.S. Senate, reportedly has agreed to a settlement of charges under the False Claims Acts of financial fraud and false expense claims submitted to Medicare. Since 2000 the company has paid $1.7 billion in civil and criminal penalties. A second large hospital chain, Tenet Healthcare, is under federal investigation in a number of areas, including Medicare billings, allegations of kickbacks to physicians for sending patients to its hospitals, and possible performance of unnecessary surgery at some of its hospitals.

According to James Wedick, head of the FBI’s white-collar crime unit in Sacramento, “Heath-care fraud is rampant in California.” Southern California, with a heavy concentration of poor people and immigrant communities, has been particularly vulnerable to fraud. The Los Angeles Times reports that, in the last few years, criminal charges have been filed against some 700 people and companies for stealing large sums from California’s Medi-Cal program (the state’s Medicaid system) by the state attorney general and the U.S. attorney’s office, which have won almost $100 million in restitution.

Nationally, purchasing agents that negotiate medical supply contracts for hospitals but receive sales fees from the manufacturers have been accused of unethical practices that have boosted prices.

Fraud and abuse may not be major factors in the explosion of costs, but attempts should be made to control them better. The Bush administration has proposed a plan to restrict gifts and rewards that pharmaceutical manufacturers give physicians and insurers to encourage the prescribing of particular drugs, but drug companies and physicians are resisting it strenuously.

In the 1990s, managed care was the chief means used to control costs, and it enjoyed a period of success. Based on the model of the health maintenance organization (HMO) that provides comprehensive health services to its members for a fixed prepaid fee, managed care was seen as offering loss prevention by keeping members healthy. The burgeoning HMOs, moreover, sought to hold down costs through budgeting and stringent controls, e.g. limiting services to those required, curtailing the length of hospital stays.

Meanwhile, the federal government had initiated cost control measures to deal with the Medicare program’s mounting financial crisis. These included setting maximum limits on the amounts paid for specific medical services, reducing hospital reimbursement rates, limiting physician fees, establishing a prospective payment system (PPS), and enacting a resource-based relative-value scale for paying doctors. The PPS set up 477 diagnostic-related groups (DRG), with a flat amount to be paid to each hospital for the same type of care (with some adjustments for rural and teaching hospitals and those serving the poor). In 1992, Medicare introduced the Resource Based Relative Value Scale, which assigned relative weights to each physician activity.

Since the new approaches led to fewer hospital admissions, shorter stays, reduced physician payments, and financial savings, private providers also adopted them. Managed care in the private sector was successful for some years in holding down costs (between 1993 and 1999, medical spending as a share of GDP remained constant), and HMOs came to dominate the health care system. HMO enrollments shot up from 20 million in 1985 to 81 million in 2000. HMOs implemented the DRG technique of standards for a given medical condition and were able to substantially cut hospital admissions and lengths of stay. At the same time, hundreds of hospitals closed and others merged, reducing excess beds, allowing the survivors to spread costs over a wider patient base.

Major savings for HMOs came from wringing out easy-to-control costs, and there apparently were enough waste and excessive fees in the system in the early days to allow savings without significant adverse health consequences. Yet the success of managed care bred opposition. Most physicians, even those still in private practice, were now connected with managed care systems, and many complained of speed-ups, lower reimbursement, and interference with patient care, since administrators could overrule their decisions on treatment needed. Nurses claimed that transferring some of their work to aides and orderlies, in an attempt to save money, also resulted in poorer quality of care.

Refusal to authorize costly procedures not deemed necessary and abbreviated hospital stays led to a public outcry against HMOs. As a quip of the time put it, patients were discharged “quicker and sicker.” Under this pressure, HMOs began to reverse their policies. They relaxed limits on care and expanded people’s choice of doctors and hospitals. Without a firm foot on the brake, physicians and patients began using more services and more expensive ones, and HMOs suffered financially. They have bounced back and many have become profitable again, but by sharply raising their premiums. Companies that provide insurance to their employees have been left to pick up the tab.

Let us examine some of the strategies employers have implemented to contain costs, including self-insurance, strengthening their bargaining power, employee cost-sharing, defined contribution plans, and wellness programs.

Some employers self-insure rather than purchase policies from insurance companies or managed care plans. Self-insurance plans often include stop-loss coverage, whereby a commercial insurer pays claims beyond some maximum dollar limit. A self-insurer usually signs an administrative-service-only contract with an outside company to process claims and pay benefits. Self-insurance may provide better control and financial savings in commissions, risk charges, and insurers’ profits, and can improve cash flow, since the employer, rather than an outside insurer, earns interest on the funds held for meeting future claims.

Small companies cannot resist when their large health care providers raise fees, so some have formed alliances to bolster their position. One coalition, the Chicago Business Group on Health, was able to negotiate lower premiums for its 67,000 HMO members, saving the group close to $10 million. Larger companies may have clout on their own for direct contracting with hospital and physician networks. One form of direct contracting that is not new is the Preferred Provider Organization (PPO), an arrangement whereby employers or health plans contract with physicians and/or hospitals to provide services to their members at discounted fees. A PPO is a fee-for-service arrangement under which employees have the freedom to choose among approved providers, but a PPO can lower fees to purchasers and give providers a larger clientele. PPOs are becoming more popular, as some companies switch to them from HMOs.

General Motors, which spent $4.2 billion last year on health care for its employees and their dependents, is taking a different tack. Having lowered charges from auto parts suppliers by helping them improve their efficiency in order to hold down costs, GM is attempting to do the same with health care providers and insurers. The company has formed a “Healthcare Initiatives” business unit to work with medical plans and providers to trim their inefficiencies and cut their costs. GM also rates the quality of care provided by the HMOs with which it deals and those that rank poorly for two years are dropped.

The California Public Employees’ Retirement System, covering 1.2 million state and local employees and their families, has reduced the number of plans offered and is working more closely with existing plans through Blue Shield, Kaiser Permanente, and some regional insurers. Indeed, many companies are reviewing the health plans they currently offer and eliminating those that are not cost-effective.

Another cost-control mechanism, which may be combined with others, is to transfer some of the increased costs to employees and/or retirees. The latter group is particularly vulnerable. In a survey conducted by the Henry J. Kaiser Foundation and Hewitt Associates, 95 percent of the respondents said they would continue to subsidize health insurance for current retirees and their spouses, but 85 percent of them would pass on more of the coverage costs to retirees. More than one-third of the nation’s large employers that offer health insurance to retirees have stopped the benefit for future retirees or expect to do so within the next three years.

Transferring costs to active employees can lead to other problems, particularly if employees have to pay more at a time when their incomes may be declining as overtime work disappears. Difficulties may be most acute when dealing with unionized groups, and adroit management is required for successful implementation. (3) Cost sharing takes many forms, from ending total employer financing or increasing the employee portion to instituting higher deductibles and/or coinsurance fees. Chronically ill employees may be hit hard, but placing limits on employee annual payments and steering them to the most efficient providers can ease their burden. Since prescription drugs can account for 20 percent of claims, companies are scrutinizing records to end over- and misuse of drugs. Some are instituting tiered co-payments designed to encourage employees to economize. Under these systems, employees’ portion of drug costs is lower if they choose alternative medicines or generics. Cost savings on generics, however, are declining. Although they remain less expensive, their prices are rising even faster than those of brand name drugs. Some companies have been forced to cut benefits, either the amounts paid or coverage of particular services. Either way, the employee has to pay more for health care. As a last resort, others, usually smaller firms, have simply stopped providing health care coverage for their workers.

Seeking to overcome the many problems associated with major cost increases which are not amenable to employer control, many firms are attempting to involve employees in finding solutions. Under current arrangements, with employers paying all or most of the cost of insurance, employees have little incentive to economize and, even if they wanted to, they usually lack the knowledge of how to do so. Providing them with information as to provider performance, alternative procedures, and the like, can help with the latter problem. A promising strategy for handling the former is to put employees in charge of making their own decisions about health care spending.

One approach to employee empowerment has been to give employees vouchers with which to purchase their own health care, but vouchers may be considered income and thus be taxable. The preference, therefore, is for defined contribution plans under which a company funds a medical spending account for each employee with a given amount of money that the employee can use as desired. In some cases, money left in a worker’s account at the end of the year is split with the employer; in others, it stays with the employee and rolls over to the next year, and the health care account grows in value over time. Some companies allow employees to take funds left in their accounts with them when they leave. The major advantages for an employer of a defined contribution plan are limitation on costs and certainty about what those costs will be.

The defined contribution approach, however, tends to undercut the basic premise of group insurance—spreading the risk. Healthy workers benefit, but sick ones bear a greater burden because when the money in an employee’s account is depleted, a high deductible must be paid before additional coverage becomes available. Indeed, when a company offers employees a choice of plans, the healthy ones are more likely to accept the defined contribution option, leaving sicklier workers in the existing plans. The adverse selection, of course, makes the existing plans much more costly.

Companies can save money on health care costs by helping to keep employees healthy. Some companies are adopting a total cost approach—that is, one that accounts for the positive impact health care has on production efficiency as well as the negative impact of its cost. They recognize that keeping employees healthy not only can hold down medical costs, but can also contribute to lower absenteeism and improved productivity. Many, therefore, operate “wellness” programs that range from providing employees with quick access to medical information to running in-house exercise facilities. They also encourage employees to follow life styles that promote good health—nutritious diets and avoidance of tobacco—and conduct programs to deal with alcohol and substance abuse.

A number of companies offer on-site primary care, where employees can receive regular physical examinations and preventive health care screenings. These are voluntary programs, but financial incentives may gain participation. Hughes Electronics, for example, cuts insurance premiums $200 for those employees taking advantage of its risk assessment program. Some companies also operate disease-management programs targeted at those with chronic ailments (e.g., diabetes, asthma) to help them establish regimens, including use of self-monitoring devices, to control their conditions. Such programs may involve the individual’s physician in the effort to control chronic conditions.

Studies by William D. Nordhaus of Yale led him to conclude that for every dollar spent on health care in the 1980s society reaped $2 in benefits. Since then, however, a number of factors have contributed to mounting costs that outpace the benefits achievable by employer-sponsored programs such as those detailed above. None of these factors is readily amenable to control by those providing insurance. The situation will only get worse over time, as the explosion in medical technology continues. Technological advances relieve human misery and prolong life; they also tend to be expensive. Meanwhile, the population is aging and baby boomers are becoming old folks who will require more health care. In short, the nation faces a crisis with respect to health care not very far down the road. In fact, the crisis may already have arrived.

So far, our review has shown that actions employers can take to curb escalating costs are circumscribed and societal solutions must be sought. We can begin to understand the range of society-wide alternatives open to us by comparing the U.S. system as it exists now to those of other developed countries.

Although many Americans lack insurance coverage, most have a substantial measure of protection against medical care costs. Our record of improved health, moreover, has been achieved with leaving freedom of choice of physician or hospital to the individual and, even with managed care, the patient retains a good deal of choice. Americans demand, and receive, more health care than citizens of other nations and, unlike the situation in other nations, we have ready access to high-technology treatments and elective surgery. Despite its achievements, Americans express greater dissatisfaction with their health care system than do citizens of other nations.

Unlike the U.S., most other countries have some sort of public health care program. Each one differs, but they share some common features: virtually universal coverage, with everyone contributing to finance the system, and various forms of cost control. All utilize some form of (usually compulsory) national health insurance, except for the United Kingdom, which in 1948 established a government-operated national health service. The United States is most unlikely to follow the British model, so let us focus on the insurance approach, typified by the German and the Canadian prototypes, as well as a French hybrid system.

The German approach can be traced to the middle ages, but was universalized in 1883 by Bismarck. Under the German system, nonprofit sickness funds are the major providers. There are more than one thousand funds, most serving lower level workers and others white-collar and managerial employees. Ten percent of the population has private insurance, and some, such as those in the military, have direct government coverage. The sickness funds are half employee/half employer financed. Fee schedules for physicians are set by a point system, but the dollar (euro) equivalent of a point is determined through negotiations.

Canada’s governmental national health insurance system was established in 1971. The provinces operate their own plans, which must by law be comprehensive, universal, publicly administered, portable, and accessible. The insurance system has affected mainly the financing of health care rather than its delivery. Financing differs by province, e.g. payroll taxes, general revenues. The federal government also contributes and it is basically a tax-based single payer system in each province that covers about three-fourths of total health care costs.

Costs are controlled by assigning each hospital a budget to which it must adhere and negotiating fees with physician associations. Until it enacted national insurance, Canada’s health expenditures were similar to those of the United States, but today Canada achieves comparable health results, while spending a much lower percentage of Gross National Product on health care.

However, the Canadian system is under stress. Although 85 percent of Canadians rate their health services as very good or excellent, there are growing complaints from physicians, pharmacists, and ancillary workers about being overworked and by patients about having to wait weeks for specialist consultations and high-tech treatments. The culprit appears to be a drop in the federal share of health care spending. As a result, Canada’s system is under funded. A recent report by a government commission has recommended an extension of benefits (e.g. home care), considerable structural change, and a major increase in federal funding, but even with the additional costs those changes would entail, the system would still be inexpensive relative to the United States.

France represents a third type of system, a hybrid in which the poor get free treatment and the rest of the population is covered by a combination of the government’s social security system and cooperative insurance groups (mutuelles). Individuals can also purchase supplementary coverage and pay out-of-pocket for uncovered treatments. France’s health service is among the best in the world, with high life expectancy, no waiting lists for hospital admission, and house calls by general practitioners. It is costly, with health care spending equal to 10 percent of GDP, but that is still well under the 13 percent of GDP spent in the United States.

Despite prior rejection of public health insurance, we have reached the point where the issue must be reconsidered. Since health care perfectly fits the insurance principle—the pooling of risk—insurance offers the best approach. Most people are healthy in any given period of time, but everyone faces the risk of falling ill and requiring medical treatment, whether for a sore throat or for cancer. Although the amount of sickness in the total society can be estimated with a significant degree of accuracy, individuals can neither predict possible illnesses nor save enough money to cope with serious ones. Insurance allows people to pool their risks by paying small shares each of the total prospective cost that are then transferred to an organization—an insurance company or government agency.

Assuming agreement on the effectiveness of insurance to deal with the incidence and cost of health care, the operating questions are who should offer it, who should pay and how much, and whether coverage should be voluntary or compulsory. Currently, insurance is voluntary for all except the aged.4 Private carriers provide the insurance and employers pay for most of it, with individuals picking up the rest. This workplace-based system, however, leaves 41 million Americans uninsured, a number that grows continually. Since coverage is not portable, insured employees are fearful lest they lose coverage because of downsizing, and the loss of insurance is moving up the income ladder. The 1985 Consolidated Omnibus Budget Reconciliation Act attempted to deal with this problem by requiring large employers to offer extension of group health insurance benefits to terminated workers, but extensions are limited in time and entirely at the expense of the displaced employee.

There is a strong economic case to be made against the current system. It discourages workers from changing jobs, deterring necessary labor mobility and preventing optimal utilization of the labor force. It places most of the cost burden on the companies providing insurance to their employees, allowing others to escape, thus distorting product and service markets. The system can no longer accommodate a growing labor force. The number of uninsured increased by 5 million in the high-job growth period, from 1992 to 1998, because most new jobs created were in small and service businesses less likely to provide coverage than large companies. Since this trend is likely to continue, we can expect the ranks of the uninsured to continue to swell.

In the last two decades, the United States’ economic policy has moved away from government intervention to reliance on free markets. How dare we then even contemplate establishing public health insurance? The answer is that health care is a social good. If people forego necessary medical treatment because of its price, they suffer, and society suffers. In this, the health care market differs from the market for widgets. If the price of widgets rises, people can do with fewer of them or switch to substitutes without great harm, but for health care substitutes are not readily available.

Furthermore, a focus of recent economic theory has been on the role of information in competitive markets. In health care, consumers suffer from a dearth of information that they can understand, and even if they had information, they still would lack the expertise to make rational decisions based on it. How does one choose whether to have radical bypass surgery or some other treatment for heart disorder? Clearly, people are dependent upon the advice of the physicians treating them.

Thus, there is a very strong case to be made on economic grounds for moving to a public health insurance system. Let us briefly discuss, however, some different proposals. One option that has been advanced is to mandate employer health insurance. Known by the rubric “play or pay,” it would require all employers to offer their employees a choice of health insurance plans or pay a tax. The federal government would pick up the tab for the rest of the population. We believe that much of what is wrong with the current system is that it is workplace-based; “play or pay” would just perpetuate and even compound the defects of labor immobility and employer burden.

Another idea is to have the states establish their own insurance systems. In 1974, Hawaii adopted its own version of “play or pay,” the Payroll Health Care Act that requires employers to provide health insurance to all full-time employees, but there has been no rush for other states to follow suit. California is contemplating a state insurance system, but in view of its current budget deficit crisis, action on the proposal is not likely. Any state-by-state approach has serious shortcomings. First, unless all the states adopted insurance systems, we might only worsen the present inequities. Second, even if the states were forced to adopt health insurance, we would end up with 50 different systems and each state trying to gain competitive advantage by having a cheaper, and consequently less adequate, program than its neighbors.

What is required is a national program that provides comprehensive health care insurance to all Americans. Such an approach might involve some form of public-private sector cooperation or be a wholly public one. In fact, we already have the institutional apparatus for the latter. The Social Security Act could be amended to include health insurance for all. Medicare could be subsumed within the new system, obviating its adverse selection problem. The financing arrangement already exists but, of course, an increase in the level of payroll taxes would be required. General revenues would be used for the poor. The payroll tax is easy to collect and is an increasing source of revenue as the economy grows. While the payroll tax falls more heavily on lower-income workers, the history and popularity of Social Security indicates that it is widely accepted as equitable. Such a national health insurance system would solve the problems of labor force mobility, free riders, a more equitable sharing of costs, and protection for everyone while preserving patient choice. It should not add to current expenditures on health care and, in fact, should lead to savings through centralized and streamlined administration.

Having reviewed the American health care system, we have concluded that it has serious deficiencies. It leaves millions without coverage and others with deteriorating coverage. A good deal of the unreimbursed costs of caring for the large number of Americans without health insurance is transferred to the insured. Employer-provided coverage is not portable, reducing labor mobility and threatening the security of those who change jobs.

The chorus calling attention to the defects of our health care system is growing louder, but we believe that the solutions being proposed in Congress are of little help. The Republicans are pushing tax breaks for individuals who purchase insurance and help to small business to buy insurance in the open market, while the Democrats are calling for expanded eligibility for Medicaid and other programs to aid the poor. Neither would solve basic problems.

Unfortunately, the prospects of achieving meaningful reform quickly are dim. The nation is absorbed with resisting terrorism, a possible preemptive war against Iraq, a weak economy, and growing federal, state, and local government deficits. Besides, based on the disastrous experience of the Clinton Administration in attempting to deal with the health care question, politicians of all stripes are wary of wading into troubled waters (although some Democrats may plump for some sort of national system as a way of differentiating themselves in the crowd of candidates seeking the presidential nomination in 2004).

At this time, therefore, neither government nor companies can do the job of either extending health care coverage or containing exploding costs under the present system. Whatever health care system we eventually end up with, its success in containing costs will depend heavily upon changes in attitude on the part of the American people. We will have to accept the fact that we cannot have everything. It is not that we are greedy users of health care services. On the contrary, people in other nations visit physicians more often, go to hospitals more and stay longer. However, Americans insist on the latest and most expensive treatments, even when they are not necessarily more successful or actually needed. Also, though people are loath to raise the issue, our society spends an inordinate amount of money providing medical care to the dying. We do this in the name of humanity, but often we are preserving pain and suffering rather than life. Americans must learn to curb their expectations and recognize that health care has to be rationed and delivered in a more rational manner than currently.

The nation will have to come to grips with the health care crisis before long. We should recognize that there is no perfect system and that we must look only for the one that best meets our goals and not be afraid to take actions because they seem to contradict preconceived ideological notions, left or right. We repeat our basic conclusion that the most feasible approach lies in applying the principles of Social Security, the most popular public program ever enacted, and instituting national health insurance within its framework.

1. In the forthcoming volume commemorating IRC’s 75th anniversary (Bruce E. Kaufman, Richard A. Beaumont and Roy B. Helfgott, eds, From Industrial Relations to Human Resources and Beyond, M.E. Sharpe, 2003), Professors John F. Burton of Rutgers and Daniel J. B. Mitchell of UCLA contend that the crucial event had come earlier. The progressive Republican governor of California, Earl Warren, had formulated a single-payer, fee-for-service comprehensive state health plan, to be financed by a 3 percent payroll tax split between employers and workers, but it was defeated in 1945 by a single vote in the state assembly. They conjecture that, had the Warren plan been implemented, President Truman might have sought to support existing state initiatives rather than a purely federal program. A federal-state partnership, using the unemployment insurance system as a model, might have had greater appeal to conservatives in Congress and, thus, a stronger chance of enactment.

2. In West Virginia in the winter of 2002, surgeons in effect went on strike, refusing to perform surgery because of the high cost of malpractice insurance.

3. For example, as of this writing the International Union of Electrical Workers and the United Electrical Workers were intending to strike General Electric because the company had announced employee increases to health care copayments.

4. But, while the principle of policy risk applies to the total group of the covered aged, risk is not averaged across the entire population. I.e., the high cost of medical insurance for the aged is not balanced against the lower costs incurred by younger people.

Drew E. Altman and Larry Levitt, “The Sad History of Health Care Cost Containment As Told in One Chart,” Health Affairs, January 23, 2002

Business Week, August 26, 2002

Business Week, October 14, 2002

Peter F. Clark, “Health Care: A Growing Role for Collective Bargaining,” Collective Bargaining in the Private Sector, Industrial Relations Research Association, 2002
David M. Cutler, “Equality, Efficiency, and Market Fundamentals: The Dynamics of International Medical-Care Reform,” Journal of Economic Literature, September 2002

HRFocus, March 2002

Lexis/Nexis, April 8, 2002

George E. Rejda, Social Insurance & Economic Security, 4th ed., Prentice Hall, 1991
Joseph White, Competing Solutions: American Health Care Compares and International Experience, Brookings, 1995