Looking at alternative ways to pay for health care

In looking at alternative ways to pay for health care, we must appreciate that health care does not fit well into the traditional insurance model. Insurance is based on the concept of the random hazard: houses will burn down somewhat at random, people will get into car accidents somewhat at random. It is possible to separate people into risk categories, but within a risk category, hazards are assumed to occur somewhat randomly. One can predict the average rate at which hazards will occur within a certain risk group, estimate the aggregate cost of these hazards, add on a certain percentage for profit and administrative costs, and divide the total by the number of people to be insured. This gives the insurance premium to be charged. Two aspects of health care make it particularly inappropriate for this insurance model:

1. Rather than being a truly random occurrence, the need for health care is to a large extent defined by physicians. The pattern of treatment and the associated costs of an illness or injury can vary substantially from physician to physician.

2. Health insurance is particularly subject to the problem of "moral hazard": once a person is insured, that person is more likely to define a problem as an illness and is more likely to seek care.

These factors make it difficult to predict health care expenditures for a population group. As a result, many traditional insurance companies shied away from insuring for health care. Before the 1930s, few options were available for purchasing insurance to cover the cost of medical care. Those plans that did exist usually provided services directly to members of certain employee or other work-based groups and were not available to the general public.

This all changed during the Great Depression of the 1930s. The inability of many individuals and families to pay the cost of medical care led to the creation of the Blue Cross and Blue Shield programs. Both the American Medical Association and the American Hospital Association supported these new plans, as long as doctors maintained control over medical decisions. By 1939, the majority of states had developed insurance programs of this type. Before World War II, these insurance plans covered a relatively small number of people. However, an important decision was made in the 1940s that was to have farreaching effects on health insurance and health care. During World War II, to prevent inflation, the federal government placed price controls on most consumer goods. This included a freeze on all wages. The government ruled, however, that any fringe benefits from work were exempt from price controls. Thus, employees and their labor unions could not bargain for increased wages, but they could bargain for better health insurance as a fringe benefit. These policies carried over into the period after World War II, leading to greater and greater emphasis on increasing fringe benefits from work as well as wages. The main fringe benefit workers sought was health insurance.

A second government decision was to have equally powerful effects. In 1954, the government ruled that fringe benefits did not count as taxable income and thus were not subject to income tax. The combination of these two policies has had profound effects on the way we pay for health care as a society and what we have come to expect from health care as individuals.

If an employer wanted to raise an employee's pay by $1, the employer would have two choices: give the $1 as additional cash wages or use the $1 to purchase additional fringe benefits. To the employer, the two options are roughly equivalent, because either can be considered a tax-deductible business expense. (The employer would have to pay certain payroll taxes on the cash contribution that are not required to be paid for the added fringe benefits.) However, from the perspective of the worker, the two options look very different. Under tax law, the added $1 of wages would be subject to a combination of federal, state, and Social Security taxes that would, for a typical middleincome worker, eat up as much as 44¢, leaving the worker with a net gain of 56¢. On the other hand, by taking the added $1 as fringe benefits such as health insurance, the worker would gain a full $1 worth of benefit, because no taxes would apply. To the worker, it is often preferable to take a wage increase as added fringe benefit rather than as cash wages. To the employer, it makes less difference.Workers have thus come to expect to receive their health insurance as a fringe benefit of their employment.

In essence, this policy provides a federal tax subsidy for the purchase of health insurance as a fringe benefit. It is not a direct subsidy, but rather an indirect subsidy, in that less money comes into the federal treasury. This federal subsidy costs the treasury tens of billions of dollars in lost tax revenues every year and constitutes the third largest federal health care program after Medicare and Medicaid. The laws that created this subsidy were passed to address problems very different from health insurance, yet their cumulative effect over time has been to create a de facto national policy of employmentbased health insurance.As is often the case, policy decisions at the federal level have long-range effects that were never envisioned at the time of their original passage.

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3. Medicare Coverage under Supplemental Part B
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4. Medicare Prescription Drug Coverage
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5. Financing Social Security and Medicare
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6. Medicare Advantage contains five different types of health plans
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7. Competition between Medigap and Medicare Advantage
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8. Health Insurance firm Medicaid Managed Care
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9. Medicare services providers and physician capitation
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10. Indemnity payments and marginal costs for Medicare patients
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