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Volume 2: Health Insurance, Part I

1945 - 2008: Paging Doctor Frankenstein

“You can check out any time you want. But you can never leave!” - Eagles

Nobody would have deliberately set out to design the health insurance system we have. It makes no sense. Incentives are misplaced, negative externalities abound, inefficiencies are layered on inefficiencies. And the politics of health insurance are toxic; any changes that are made will produce some winners and some losers, and people who are currently satisfied reasonably fear change.

We are going to tackle this system in 3 parts. Part I describes how our health insurance system came to be. Part II will describe what the Affordable Care Act, or “ACA”, did and why. With a new administration coming in, the Affordable Care Act will be in the crosshairs. Part III will discuss some of the changes being proposed, and I’ll opine as to the likelihood of various outcomes.

  • Why did employers get into health insurance?

  • Who is getting their health insurance from the government?

  • What did the health insurance ecosystem look like just before the Affordable Care Act?


Why did employers get into health insurance?

Before World War II, health economics were simple; almost all Americans paid directly for their medical care. It was a time before MRIs, billion-dollar wonder drugs, and soaring levels of joint replacement(1). We all know how far medicine has advanced in the span of a lifetime, but let’s take a minute to imagine a world without:

  • Antibiotics (discovered 1928, not widespread until after WW2)

  • Chemotherapy (1940s)(2)

  • Tylenol (1948)

  • Pacemakers (1958)

  • Ultrasounds (1953-1965)

  • Vaccines for typhus (1937), flu (1945), polio (1955), measles (1964)

  • DNA fingerprinting (1985)

I can go on, but you get the point – there just wasn’t nearly as much health care you could buy, so the issue of how to pay for it was not so critical.

In the 1930s Blue Cross launched the first product that looks at all like modern health insurance. But the market really took off due to World War II(3). Wars generally cause inflation, and FDR reasonably worried that the largest war effort ever would do the same to the U.S. In order to fight potential inflation, the National War Labor Board was created with the power to prevent work stoppages and control wages in critical war industries(4). But they added a loophole which is still having unintended consequences: health benefits were exempted from these wage controls. Companies couldn’t compete for workers on salaries, so they started competing on benefits. Because the premiums are tax deductible for the employer - and untaxed for the employee – it is more efficient for an employer to buy the insurance than to pay employees more and let them buy it themselves. In 1960, the Federal Employees Health Benefit Program was created(5). Around that time most federal, state and local government employees started receiving health benefits from their employer also.

Fast forward a bit, and health insurance became a de rigueur feature of a “good job”. Proud Jewish mothers of recent college graduates started bragging that their kid “has a job and it even has health insurance(6).” In 2008, 58.5% of Americans received health insurance from their employer(7). But there are a few problems with an employer-based system. First, the employer will choose the health plan, which your doctor may or may not accept. Then, job switchers will almost by definition need to change plans (and thus maybe doctors). The self-employed and owners of small businesses will find it prohibitive to establish a “group plan”, so employer-based systems discourage entrepreneurship. Also, as the cost of health care has increased, more companies began cancelling their benefit plans, or at least forcing employees to pay a larger share. Finally, an employer-based system does very little for people who are out of the work force for any reason.

If people can reasonably go and buy health insurance on their own (what is called the “individual market”), these problems are mitigated. But as we will see, the individual market started to become highly dysfunctional towards the end of the 20th century.

Who is getting their health insurance through the government?

As we’ve seen, by the 1960s, employer-based plans dominated the health insurance market. But large groups of people were left uncovered, and Presidents Kennedy and Johnson began to push Congress to take action on behalf of some of these groups. Raised by President Truman as a moral obligation in 1945, it has been part of the Democratic Party’s platform to use government provided solutions to ensure universal health insurance(8). Alternatively, the Republican Party has consistently supported a market-based approach, opposing any government involvement, especially Federal(9).

Retirees were a large group of citizens who lacked insurance. Some elderly citizens maintained coverage through a retirement plan from a previous employer, but according to a 1960s study, about half of Americans over 65 were uninsured(10). With large Democratic majorities resulting from the landslide 1964 election(11), Medicare was created as an amendment to Social Security.

The basic financial structure of Medicare is therefore similar to Social Security: funded by a direct payroll tax, appropriated through mandatory spending, surplus goes into a Trust Fund (similar to but separate from the OASDI Trust Fund in Vol. 1). Originally, Medicare had two major programs: hospital/hospice insurance (Part A) and outpatient insurance (Part B). In 1997, Medicare was modified to allow seniors to receive the coverage through private plans, which came to be called Medicare Advantage (Part C). Finally, in 2006, a prescription drug program was added (Part D). It was also expanded over time to include some disabled persons under the age of 65. Today, approximately 46 million seniors and 9 million non-seniors receive health insurance through Medicare. The program has been successful at its prime goal; by 2008, only 1.7% of American seniors lacked health insurance.

The next large group without access to health insurance was, speaking broadly, poor people. But it’s misconception that Medicaid is a welfare program, with benefits going to people who are not working (either due to their choice or inability to find work). A look at the population on Medicaid shows this is not the case(12).

Even among the adults in Medicaid, it is estimated that around 72% are in families with at least one working adult(13). In other words, Medicaid enrollees are largely either out of the workforce for valid reasons or employed by a company through which they do not receive health benefits. The growth in adults in Medicaid (from 6.9 million to 10.6 million during the period 2000 to 2005) is mostly due to fewer employers offering health coverage(14).

Medicaid operates in a fundamentally different manner than Medicare (or Social Security). Medicaid is a partnership between the federal government and each state; the coverage available through Medicaid varies greatly depending on where you live(15). For states whose Medicaid systems meet certain requirements, the Federal Government is committed to picking up 50% of the total costs (wealthier states) or more (76% in Mississippi)(16). The basic Medicaid requirements to gain Federal cost-sharing are fairly low; states following the minimum will still have large populations who earned too much to receive Medicaid, but worked at jobs that did not offer benefits. Many states therefore offer Medicaid benefits to a larger population than the minimum required.

By the 1990s, there was a strong movement to try to close this “coverage gap” among minors. While history has written that Hillary Clinton’s health insurance initiative in 1993 was a failure, this ignores the very significant step of creating the State Children’s Health Insurance Program, or “S-CHIP”(17). S-CHIP works as a federal-state partnership, the same as Medicaid (in some states they are run together). By 2009, 7.7 million children under 18 were covered by S-CHIP(18).

In addition to these programs, the Government also directly provides healthcare in its role as an employer. When considering the system as a whole, these people are more similar to those in employer plans, as opposed to Medicare/Medicaid. But for completeness sake, around 35 million people have health care through their government employer – two-thirds as federal/state/local employees and the remainder through military (TriCare or Veterans Administration)(19).

What did the Health Insurance ecosystem look like before the Affordable Care Act?

We’ve now covered in fair detail how the US public and private health insurance systems came to exist. But, as we will see below, starting around 1995 strains in the system were beginning to affect more and more Americans. Let’s start with a chart to describe the status of the health insurance system just before the ACA(20).

Then, the changes in total US National Health Expenditures (NHE) after inflation(21):

Then, the decline in employer sponsored health insurance (ESI)(22) - note that this doesn’t include the fact that employee’s out of pocket costs have steadily increased(23).