2
Origins and Evolution of Employment-Based Health Benefits

History is a record of ''effects" the vast majority of which nobody intended to produce.

Joseph Schumpeter, 1938

The current U.S. system of voluntary employment-based health benefits is not the consequence of an overarching and deliberate plan or policy. Rather, it reflects a gradual accumulation of factors: innovations in health care finance and organization, conflicting political and social principles, coincidences of timing, market dynamics, programs stimulated by the findings of health services research, and spillover effects of tax and other policies aimed at different targets.

The major innovation, as described below, was the creation of alliances and mechanisms that made the employee group a workable vehicle for insuring a large proportion of workers and their families. That the employee group existed for purposes other than the provision of insurance (that is, to produce a product or service) was an important although not sufficient condition for dealing with biased risk selection and some of the other problems described in Chapter 1 and discussed further in Chapter 5.

This chapter provides a rather detailed overview of some important bases for present public and private arrangements for insuring health care. From this overview, five broad points emerge:

  1. Insuring medical care expenses is difficult for several reasons, and making private insurance workable for large numbers of workers and their families has taken considerable creativity, leadership, and some luck.

  2. A constituency for broad access to health coverage has existed for nearly a century, pressuring both public and private sectors to find new and better ways of extending that access.

  3. The path taken by the United States has diverged from that of other developed nations, particularly since the end of World War II.



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Employment and Health Benefits: A Connection at Risk 2 Origins and Evolution of Employment-Based Health Benefits History is a record of ''effects" the vast majority of which nobody intended to produce. Joseph Schumpeter, 1938 The current U.S. system of voluntary employment-based health benefits is not the consequence of an overarching and deliberate plan or policy. Rather, it reflects a gradual accumulation of factors: innovations in health care finance and organization, conflicting political and social principles, coincidences of timing, market dynamics, programs stimulated by the findings of health services research, and spillover effects of tax and other policies aimed at different targets. The major innovation, as described below, was the creation of alliances and mechanisms that made the employee group a workable vehicle for insuring a large proportion of workers and their families. That the employee group existed for purposes other than the provision of insurance (that is, to produce a product or service) was an important although not sufficient condition for dealing with biased risk selection and some of the other problems described in Chapter 1 and discussed further in Chapter 5. This chapter provides a rather detailed overview of some important bases for present public and private arrangements for insuring health care. From this overview, five broad points emerge: Insuring medical care expenses is difficult for several reasons, and making private insurance workable for large numbers of workers and their families has taken considerable creativity, leadership, and some luck. A constituency for broad access to health coverage has existed for nearly a century, pressuring both public and private sectors to find new and better ways of extending that access. The path taken by the United States has diverged from that of other developed nations, particularly since the end of World War II.

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Employment and Health Benefits: A Connection at Risk The debate about private versus public strategies for medical expense protection is longstanding and has, with the exception of programs for special populations, repeatedly been resolved in the United States in favor of private approaches. The central role of employment-based health benefits and the very substantial discretion accorded employers rest, in considerable measure, on federal laws and regulations (in particular, the Employee Retirement Income Security Act of 1974) that did not explicitly plan or envision that structure. Many of the values, pressures, and conflicts that have shaped the evolution of employment-based health benefits persist and should be factored into evaluations of this system and proposals for restructuring it. Moreover, it is important to recognize the forces that have led people in this country and elsewhere to expect both more medical care and more protection against its rising cost. These forces, which affect both public and private provision of health coverage, include an ever-accelerating pace of scientific and technological discovery that has offered new relief from pain and suffering and heightened expectations about the value of new medical technologies, products, and practices; a century's worth of professional and institutional development in health care that has made possible the delivery of biomedicine's new achievements; an increase in medical care costs that has been fueled both by economic growth and by advances in clinical capabilities and organizational resources; and a system of private and public health coverage that has for most of the last 50 years increased financial access to these advances but placed few controls on medical price inflation or overuse of medical services. On almost every front, the thrust in the United States is still expansionist—the uninsured want basic protection, the insured want restrictions on coverage eased, and researchers, providers, and entrepreneurs devise new technologies and services that further stimulate demand for care. Hence, health care consumes a greater share of national resources each year. The expansionary thrust has, however, stalled in some areas. In particular, the proportion of the U.S. population covered by private health benefits has leveled off and even shown signs of decline in the employment-based sector. Furthermore, many now question whether current medical practices and technological advances produce improvements in health and well-being commensurate with their cost. These questions reinforce policymakers' wariness about new initiatives to improve equity and access given two decades of unsuccessful efforts to moderate the flow of resources to the health sector.

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Employment and Health Benefits: A Connection at Risk Although this chapter is lengthy, it is not intended to be comprehensive. 1 Rather, the object is to provide sufficient detail to make clear that current arrangements, problems, and controversies have deep roots. By way of brief overview, Table 2.1 highlights key dates in the evolution of employment-based health benefits in the United States and in the environment that shaped its development. THE BIRTH OF INSURANCE FOR MEDICAL CARE EXPENSES In Europe and the United States, modern insurance for medical care expenses has its origins in diverse actions undertaken by unions, fraternal organizations, employee associations, employers, commercial insurers, governments, and other less easily categorized entities. The primary objective of most of these initiatives was not reimbursement for medical expenses but protection against the loss of income due to illness or injury. Early Voluntary Initiatives By the beginning of the nineteenth century in Europe, guilds, unions, mutual aid societies that crossed occupational lines, fraternal associations, and other private groups had already developed various forms of collective action to protect group members and members' families against such economic catastrophes as death of the breadwinner (Anderson, 1972; Glaser, 1991). Such efforts became more widespread as the Industrial Revolution took hold and the hazards of workplace injury and related wage loss became a major concern. Although these efforts were often described as sickness insurance, sick benefits, or health insurance, they usually did not cover medical care expenses (Faulkner, 1940; Glaser, 1991). In the latter part of the nineteenth century, however, some European mutual aid societies and other groups did offer limited medical expense coverage, and several employed or contracted with physicians and created clinics or hospitals to serve their members. In general, the voluntary nature of the programs and the often meager financial resources of their participants limited their scope. In England, where mutual aid societies were particularly strong, voluntary sickness insurance covered less than one-seventh of the population in the period just before the country adopted its first social insurance measures in 1911 (Starr, 1982). The early lack of emphasis on medical expense insurance is not surprising. Truly effective medical services were limited—and sometimes even 1   The sources cited here are not always consistent and unambiguous, especially about the period before 1960, but the committee has attempted to determine what is accurate insofar as possible within its resources.

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Employment and Health Benefits: A Connection at Risk TABLE 2.1 Key Dates in the Development of Employment-Based Health Benefits and Its Environment 1798 U.S. Marine Hospital Service established; deductions from seamen's pay cover costs 1847 First (short-lived) company to issue health insurance organized in Boston 1849 New York passes first general state insurance law 1853 French mutual aid society establishes prepaid hospital care plan in San Francisco 1863 Travelers Insurance Company offers accident insurance in the United States 1870s Railroad, mining, and other industries begin to provide company doctors funded by deductions from workers' wages 1877 Granite Cutters Union establishes first national sick benefit program 1906 American Association for Labor Legislation founded to promote workers compensation and other social insurance programs 1910 Flexner report on need for improvements in medical education 1910 Montgomery Ward enters into one of the earliest group insurance contracts 1910s Physician service and industrial health plans established in Northwest and remote areas 1912 First model state law developed for regulating health insurance 1913 International Ladies Garment Workers Union (ILGWU) begins first union medical services program 1915-1920 Efforts to establish compulsory health insurance programs fail in 16 states 1927 Committee on the Costs of Medical Care established 1929 Stock market crash followed by Depression 1929 Baylor group hospitalization plan founded (first Blue Cross plan) 1935 Social Security Act passes without health insurance provisions 1937 Blue Cross Commission established 1940 Predecessor of Group Health Association of America established 1943 War Labor Board rules wage freeze does not apply to fringe benefits 1945 Kaiser Foundation Health Plan opens to non-Kaiser groups 1947 Taft-Hartley Act requires collective bargaining on wages and conditions of employment 1948 McCarran-Ferguson Act gives states broad power to regulate insurance 1949 Supreme Court upholds National Labor Relations Board ruling that employee benefits are subject to collective bargaining 1954 Revenue Act confirms employer-paid health benefits are not taxable as employee income 1965 Medicare and Medicaid legislation adopted (effective 1966) 1968 Firestone Tire and Rubber Co. begins to self-fund health benefits 1971-1974 Economic Stabilization Program (wage-price controls) in effect for health sector 1973 HMO Act requires most employers to offer federally qualified HMOs 1974 Employee Retirement Income Security Act passed 1974 Washington Business Group on Health organized (predecessor) 1978 General Motors cost-containment reports initiated 1985 Budget Act requires employers with 20 or more employees to offer continued health coverage to terminated employees and dependents for 18 or 36 months 1990 Financial Standards Accounting Board requires companies to record unfunded retiree health benefit liabilities on balance sheets (effective late 1992)   SOURCES: Somers and Somers, 1961; Munts, 1967; Anderson, 1968; Wilson and Neuhauser, 1974; Brandes, 1976; U.S. Department of Health, Education, and Welfare, 1976; Starr, 1982; Stevens, 1989; Health Insurance Association of America, 1991b; Employee Benefit Research Institute, 1992c.

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Employment and Health Benefits: A Connection at Risk suspect—well into the nineteenth century (Somers and Somers, 1961; Anderson, 1968; Poynter, 1971; Ebert, 1973; Knowles, 1973; Starr, 1982; Stevens, 1989). Hospitals were, to a considerable extent, sick houses for the poor and those infected with contagious diseases. Medical practices had little capacity to prevent or alter the course of disease. At best, the goal or reality of medical care was "to cure seldom, to help sometimes, and to comfort always." By the turn of the century, advances in public health and, to a lesser extent, biomedical science had brought significant changes in what medical care could accomplish. For example, developments in bacteriology and anesthesiology were making safer and less painful surgery a reality. As modern medicine helped transform hospitals into places where the sick could be effectively treated, numbers of hospitals and capital investments in them multiplied. Their growing stature and value were suggested by the fact that some hospitals began to advertise, establish prices, and actually charge fees to those patients who could afford it. Still, in 1900, physicians remained limited in what they could actually do for many patients. In a telling statement made that year, one physician argued to his colleagues that the practice of medicine is "'not only diagnosis and autopsy but the treatment and care of patients"' (Jacobi, 1900, quoted in Hill and Anderson, 1991, p. 52). Although hospital costs were on the verge of becoming an important concern for workers and their families, protection against income lost due to illness and injury remained a more significant objective than medical expense protection.2 As European ideas and institutional forms diffused to the United States, often through immigrants, various kinds of mutual aid or benevolent associations, fraternal organizations, workers clubs, unions, and other similar concepts and structures were adapted to this country's circumstances and culture (Munts, 1967; Anderson, 1968, 1972; Brandes, 1976; Weir et al., 1988). Quite early in this process, in 1853, La Société Française de Bienfaisance Mutuelle established the first prepaid hospital care arrangement, which was linked to the hospital it founded. A German association started a year later and began to offer hospital services in 1855. Patients with lifetime care contracts purchased during the 1930s from the latter plan were still being cared for in the 1960s by the restructured, surviving hospital (Trauner, 1977). Notwithstanding some exceptions, most American benevolent societies and similar organizations, like their European counterparts, focused on income, not medical expense, protection. For example, the 179 national fra- 2   Although data are scarce, one figure for the pre-World War I period suggests that wage losses due to worker illness and injury were 2 to 4 times greater than worker expenses for medical care. For families as a whole, lost income and medical costs were about equal because dependent wives and children might incur medical expenses but generally had little or no income to lose (Starr, 1982).

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Employment and Health Benefits: A Connection at Risk ternal organizations in the United States paid out $97 million for benefits in 1917, but only 1 percent of this amount went for medical expenses (Starr, 1982). Among unions, the Granite Cutters Union is cited as establishing in 1877 the first national sick benefit program. It was probably, like most early efforts, more an income protection than a medical expense plan. The International Ladies Garment Workers Union followed a different approach, creating the first union medical services program in 1913 and incorporating the first union health center four years later. (Later, in 1940, the garment workers began the first multiemployer welfare funds to avoid lost benefits due to job changes or company failures.) Important as such union initiatives were, the main focus of union activities and concerns tended to be on organizing members and on surviving employer resistance to a restructuring of the fundamental relationship between workers and management. Early employer programs include frequently cited examples from the mining and lumbering industries and the railroads (Somers and Somers, 1961; Munts, 1967; Anderson, 1968; Brandes, 1976; Starr, 1982). These employers had a practical interest in the provision of medical services to injured or ill employees who often worked in isolated geographic areas. The scope of some of these efforts is suggested by the fact that, by the turn of the century, there were an estimated 6,000 railway surgeons (Starr, 1982). In some—perhaps most—situations, employers arranged for the services, but workers paid for them through an innovative wage "checkoff" system. Another innovation was the development of contracts between employers and closed physician panels or prepaid plans allowing free choice of physician.3 Although these early programs represented advances in some respects, they were also criticized for using unqualified, overworked "contract" physicians and providing dismal physical facilities in some areas (Somers and Somers, 1961; Munts, 1967). After the passage of workers' compensation legislation, "industrial medicine" became more prominent and focused because companies had stronger financial incentives to identify and reduce workplace hazards. Employment-related medical programs occasionally covered not only work-related injuries but also general medical care for workers, their families, and even the larger community (Somers and Somers, 1961; Munts, 1967; Brandes, 1976). In the early part of this century, company medical services could be one component of "welfare capitalism," a range of hous- 3   For example, the Pierce County (Washington) Industrial Medical and Surgical Service Bureau was created in 1917 as a for-profit stock company that could "make contracts with employees of labor and their employers" (Pierce County Medical, 1992, p. 3). In its first quarter, it signed contracts with 21 businesses. In 1946, it reorganized as a nonprofit organization, and in 1964, it became a Blue Shield plan. It describes itself as the first successful prepaid health plan.

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Employment and Health Benefits: A Connection at Risk ing, education, social assistance, and other programs intended to socialize workers, bind them to their employer, and discourage unions. Instead of or in addition to providing company hospitals and doctors, some employers assisted employee mutual benefit associations with financial and clerical aid. Most general accounts of these associations do not make clear whether they protected against medical care expenses, and to what extent, or simply against loss of income due to injury or illness. In any case, although a few companies, such as Eastman Kodak, made large contributions to these employee programs, a 1916 Public Health Service survey found only one company of 425 that fully funded such a program, and most assistance was quite limited (Munts, 1967; Brandes, 1976). For the most part, physician organizations opposed company-provided medical care as a threat to their autonomy and income. During the early part of this century, this opposition discouraged many companies from expanding their involvement in medical care. For example, after the company doctor at Sears, Roebuck resigned because the county medical society refused him membership, his successor persuaded the company to stop providing services to workers' families at reduced prices and to provide only periodic examinations and other limited care to employees (Starr, 1982). Workers had different concerns (Brandes, 1976). Company doctors were often seen as serving the company before the patient, for example, in reporting illnesses discovered during physical examinations and in making judgments about whether injuries were work-related and thus required some compensation to the employee. Also, many workers preferred to choose their own physician. As a consequence of these and other concerns, unions often pressed for cash benefits instead of company medical services (Starr, 1982). Finally, in addition to the programs devised by voluntary associations, employers, unions, and other employee groups, disability and sickness insurance products created by commercial insurers constituted another institutional base for modern health insurance (Faulkner, 1940, 1960; Somers and Somers, 1961; MacIntyre, 1962; Anderson, 1972). Such products began to appear in England around 1850 to provide insurance against accidental injury, in particular, injury arising from railway and steamship travel.4 This insurance initially provided cash payments (indemnities) in the event of 4   In an interesting example of the diffusion of an innovation, Faulkner (1940) describes how architect James Batterson, the founder of the Traveler's Insurance Company, purchased an accident insurance ticket while in England in 1859 to cover him on a train trip from Leamington to Liverpool. Interested in this concept, Batterson visited both the insurance company (the Railway Passenger's Assurance Company of London) and a leading English actuary. Four years of further investigation, capitalization efforts, and legal work passed before Traveler's was chartered in 1864 in Hartford, Connecticut. Among the coverage exclusions in the earliest policies were injuries arising from disease, surgical operations, dueling, war, or intoxication.

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Employment and Health Benefits: A Connection at Risk death or total disability and gradually expanded to cover various kinds of accidents and illnesses. These early products employed the standard actuarial principles and techniques that had been developing in the fields of life, fire, and marine insurance. Efforts to extend commercial accident-and-sickness insurance, as it was often called, to expenses for medical care were intermittent and limited during the latter part of the nineteenth century and first third of the twentieth century (Faulkner, 1940, 1960; Somers and Somers, 1961; Starr, 1982). Life insurers made some efforts to add medical expense benefits to their newly developing group life insurance programs aimed at employers, but these attempts were sporadic. In general, insurers considered medical expense benefits to be actually dubious and a "frill" (Faulkner, 1940; Somers and Somers, 1961).5 Overall, as a vehicle for and influence on health insurance, commercial insurers played a relatively limited role in most European countries. They became major actors in the United States largely after World War II, once community-based organizations, hospitals, physician groups, and government policies provided evidence that private medical expense coverage was feasible. Early Public Action It was on the foundation of the early but limited initiatives of union, mutual aid, and other groups that most European governments created their policies of compulsory, subsidized medical expense protection beginning in the late nineteenth century (Anderson, 1972; Starr, 1982; Glaser, 1991). This foundation remains visible in some countries, for example, in the sickness funds of Germany. In yet other countries, it has largely been replaced by alternative structures, for example, the National Health Service in Britain. Generally, the building of publicly supported arrangements for medical expense protection was embedded in the broader development of social insurance and other policies to protect workers, their families, and others against various harms, in particular, the loss of earning ability due to old age, disability, or workplace injuries (Flora and Heidenheimer, 1981; Weir et al., 1988).6 As described in Chapter 1, social insurance for medical expenses shares common features with other social insurance programs. It is universal or nearly universal; coverage is virtually automatic or compulsory for most of the population; common basic benefits are available with- 5   Funeral expense protection, on the other hand, was so valued that millions of people paid weekly premiums for individual "industrial life" policies, which were a backbone of companies such as Metropolitan Life and Prudential (Somers and Somers, 1961). 6   A more thorough history would also cite as foundations for the policies of different nations the development of public health initiatives (e.g., sanitation and quarantines) and sick houses or hospitals.

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Employment and Health Benefits: A Connection at Risk out regard to income; payments for basic coverage are not explicitly priced to reflect the individual's level of risk; and tax or other revenue-generating policies subsidize coverage, particularly for the poor. The creation of a comprehensive array of social insurance programs was, however, uneven in its pace across nations and piecemeal in its formulation within nations (Anderson, 1968, 1972; Glaser, 1991). Bismarck is cited as the originator of statutory health insurance, which was one of the social insurance programs he initiated in Germany in the 1880s. A major objective was to defuse worker unrest. Like many later programs, this system was a product of compromises that, in this case, left the national government with far less administrative power than Bismarck had proposed. The existing sickness funds retained administrative responsibilities that persist to this day. As with many other social insurance programs, Germany's became universal in fits and starts. White-collar workers were not covered initially, and farmers were not included until after World War II. In 1907, only 21 percent of the German population was covered by sickness insurance (Starr, 1982). By the end of World War II, however, most European countries had social health insurance or other government health programs in place for major segments of their population. THE DIVERGENT PATH OF THE UNITED STATES As noted in the preceding chapter, the United States is almost alone among developed countries in lacking some governmentally mandated form of comprehensive health coverage for all or nearly all its population. Its divergent path became apparent primarily after World War II, when most other countries moved to adopt, restructure, or complete their schemes for protecting most of their population against expenses for medical care. The seeds for a more typical evolution were not totally absent in the United States. For example, the government established the U.S. Marine Hospital Service in 1798 and deducted 20 cents a month from each seamen's wages to pay for it. Unlike somewhat similar initiatives in Sweden and elsewhere, it did not become the cornerstone for a government medical care delivery or insurance program for the citizenry at large (Anderson, 1972; Mullan, 1989). The marine system eventually did evolve into an important research and public health organization, the U.S. Public Health Service. Early in this century, the instability and inadequacy of voluntary health benefit programs and the need for broad government action became a subject of public debate and agitation in this country, as it had elsewhere (Anderson, 1968, 1972; Harris, 1969; Starr, 1982). As noted above, many early employer-sponsored programs were not well regarded, and the financial instability of union and mutual aid programs and the conservatism of commercial insurers also contributed to negative opinions of voluntary private insurance.

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Employment and Health Benefits: A Connection at Risk Many were aware of the public schemes evolving in Europe and the arguments behind these developments. The Progressive Party under President Theodore Roosevelt included national health insurance in its platform for the 1912 election (Harris, 1969), and some key officials of the U.S. Public Health Service supported compulsory insurance in the belief that it would encourage more backing for public health measures (Starr, 1982; Mullan, 1989). Legislation to study and plan for national unemployment, old age, and sickness insurance was introduced in Congress in 1916 and 1917 by its only Socialist member. Hearings were held, but the legislation never passed, in part because of the pressures and distractions presented by World War I and in part because of interest group opposition (Anderson, 1968; Starr, 1982). Reflecting the federalism of the times, most initial efforts to secure government action focused on state rather than national initiatives. The following discussion first traces early attempts to secure state health insurance legislation and then examines subsequent efforts to achieve national health insurance. It turns last to initiatives in the private sector and the stimulus provided to employment-based health coverage by federal decisions affecting employee benefits and employer-employee relationships generally. Unsuccessful Early State Initiatives After workers' compensation or disability insurance for work-related injury, medical care insurance was one of the earliest targets for groups in the United States advocating social insurance against the hazards of modern industrial society (Anderson, 1968, 1972; Starr, 1982). Particularly prominent in behalf of both was the Committee on Social Insurance of the American Association for Labor Legislation (AALL), the organizing of which began in 1905 at the annual meeting of the American Economic Association.7 The AALL, whose prestigious administrative council included Jane Addams, Louis Brandeis, and Woodrow Wilson, drafted a model state medical care insurance bill in 1915, and some 16 such bills were introduced at the state level by 1920. The standards for these proposals, which were set forth by AALL in 1914 (Anderson, 1968), are summarized in Table 2.2. The actual benefits provided by the model bill included sick pay (at two-thirds of wages for up to 26 weeks); medical coverage for physician, hospital, and nursing care; maternity benefits for working women and workers' wives; and a $50 ben- 7   The social activism of social scientists in this period is suggested by the program of the 1916 annual meeting of the AALL, which included joint sessions with the American Economic Association, the American Political Science Association, the American Sociological Association, and the American Statistical Association (Anderson, 1968).

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Employment and Health Benefits: A Connection at Risk TABLE 2.2 Standards Adapted by American Association for Labor Legislation in 1914 for Drafting Model State Medical Care Insurance Bill Coverage • Compulsory participation for workers. • Voluntary participation for the self-employed. • Emphasis on illness prevention when possible. Organization and Operation • Financing through contributions from employer, employee, and the public. • Administration by employers and employees under public supervision. • Separate program of disability insurance to replace lost income.   SOURCE: Anderson, 1968. efit for burial expenses (Starr, 1982). Two-fifths of the cost would come from workers, two-fifths from employers, and one-fifth from state government; the total cost was estimated at 4 percent of wages. The objectives were to reduce the social costs of illness through effective medical care and incentives for disease and injury prevention. In 1916 the American Medical Association (AMA) established its own Committee on Social Insurance to cooperate with the AALL in studying the issue and drafting legislation (Anderson, 1968; Harris, 1969; Starr, 1982). The group was chaired by Theodore Roosevelt's personal doctor (Alexander Lambert) and staffed by a Socialist physician (I. M. Rubinow). In the same year the AMA elected as its president Dr. Rupert Blue, then surgeon general of the United States. Dr. Blue called for adequate health insurance in his presidential address (Mullan, 1989). Moreover, an AMA trustees' report argued that it was better that they '''initiate the necessary changes than have them forced on us"' (Harris, 1969, p. 5). The AMA Committee on Social Insurance concluded that voluntary health insurance under private control was unworkable and urged support for state legislation. By 1920, however, the stance of organized medicine switched from cautious cooperation to forceful opposition that lasted decades.8 One explanation is that the academically oriented leadership of the AMA was countered by "grass roots" practitioners who were reacting to the immediate reality of 8   The American Medical Association now supports legislation that would (1) strengthen Medicaid to ensure "that no poor person is left without access to needed health care," (2) require "employer provision of health insurance for all full-time employees and their families, with tax help to employers," and (3) create state risk pools to cover the medically uninsurable and those who cannot afford or otherwise obtain coverage (Todd et al., 1991, p. 2504). A number of other physician groups have developed their own reform proposals, most of which include some type of required coverage and some public funding.

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Employment and Health Benefits: A Connection at Risk 1976), some insurers warned that unless hospitals cooperated with public or voluntary health planning "we will not pay full reimbursement or continue our contract with a hospital" (Walter McNerney, quoted in Somers, 1969, p. 138). Utilization Review Historically, third-party payers tended to concentrate their cost containment energies on the unit price of medical services and to pay less attention to the volume of those services provided by institutions and practitioners and sought by patients. However, some early physician organized health plans established a form of peer review.21 Although some hospitals used committees to monitor utilization in an effort to cope with the short supply of hospital beds during World War II, the first explicit use of retrospective utilization review to control fee-for-service payments for unnecessary and inappropriate hospital services seems to have been in the 1950s (Payne, 1987). In 1954, Fred Carter, a physician, wrote in The Modern Hospital, "'Why not appoint a standing hospital staff committee designated as the "hospital utilization committee" to do in the field of hospital and medical economics what the tissue committee does . . . in the field of surgery. Abuses in the use of hospital services and facilities coming to the attention of this hospital utilization committee could be disciplined to the point of near deletion"' (quoted in London, 1965, p. 77). Apparently, high optimism about the impact of utilization review was born with the idea itself. The 1950s also appear to have seen the first attempt by health plans to encourage or require second opinions about the need for proposed surgery. The United Mine Workers Union tried to institute such a program but failed because of resistance from organized medicine (Rutgow and Sieverts, 1989). It was not until the 1970s that such provisions were successfully introduced by the Store Workers Health and Welfare Fund and other union programs (McCarthy and Widmer, 1974). The San Joaquin County Foundation for Medical Care, founded in 1954, not only served as a model for many IPAs but also helped inspire several medical societies to organize peer review of health care utilization and quality. FMCs pioneered many utilization review tools, including model treatment profiles to assess physician performance, protocols for reviewing ambulatory care, and computerized screening of claims (Egdahl, 1973). 21   For example, soon after its creation in 1917, what is now the Pierce County (Washington) Blue Shield plan established a Consultation Committee and required that physicians check with a committee member to determine whether an operation was appropriate before they would be paid. The plan also warned physicians about their overuse of prescription drugs and private duty nurses.

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Employment and Health Benefits: A Connection at Risk By the early 1960s, more than 60 Blue Cross plans reported programs to review claims for the appropriateness of hospital admissions, and more than 50 looked at the length of stay. Some required physicians to certify at admission that hospital care was necessary for cases such as diagnostic and dental admissions, and more than two dozen required physicians to certify the need for continued hospital care after a specified length of stay (Fitzpatrick, 1965; Young, 1965). In a prescient comment, Odin Anderson noted in 1968 that as payers showed increasing interest in medical practice patterns, "the central concern of the medical profession today and in the years ahead might well be 'bureaucracy"' (Anderson, 1968, p. 161). Impact of Early Cost Management Efforts The various tools used to control costs from the 1930s into the 1960s may have had some impact, but they often were neither rigorously applied nor rigorously evaluated. In general, concerns about controlling costs were still overshadowed by society's desire to expand access and improve health outcomes through the development and implementation of advances in medical care. Government was not a major actor, but neither had marketplace competition emerged as a rallying point for private sector cost containment strategies. Community-oriented programs and cooperative work with health care providers were more prominent themes in this period. Further discussion of private and public efforts to control health care costs, which greatly expanded in the 1970s and 1980s, is deferred until Chapter 6. THE LIMITS OF VOLUNTARY HEALTH BENEFITS AND MEDICARE AND MEDICAID As the growth of employment-based health benefits was making such coverage an expected feature of personal life for many Americans, some limitations of voluntary private insurance were simultaneously being identified. The elderly were singled out as a special problem, having greater medical needs but less financial protection than younger individuals still in the work force (Somers and Somers, 1961; Feingold, 1966; Harris, 1969; Marmor, 1973). In 1960, about half of those aged 65 to 74 were thought to have some form of private health insurance—frequently more limited than that available to younger individuals—but only one-third of those over 75 had any protection. Somers and Somers (1961) estimated on the basis of data acknowledged as fragmentary that health insurance met perhaps "one sixth of total medical costs of the insured [but] one fourteenth of the total for all the aged" (p. 445). The consequences of being uninsured had become more significant as the medical advances associated with World War II and the postwar com-

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Employment and Health Benefits: A Connection at Risk mitment of significant resources to biomedical science and hospital construction expanded both the problems medicine could treat and the costs of treatment. Moreover, growth in personal income, private insurance, and open-ended third-party reimbursement practices and constrained growth in the supply of physicians combined to place inflationary pressure on medical care prices. Between 1950 and 1960, employment in the health care sector rose by over 50 percent, compared with only 10 percent for employment in total (Fuchs, 1968). The amount of per diem hospital costs accounted for by salaries went from $5.11 in 1946 to $20.56 in 1960, an increase of 300 percent, compared with an increase of about 160 percent for other expenses (Colman, 1968). The number of outpatient prescriptions tripled from 1945 to 1966, but prescription expenditures went up tenfold (McEvilla, 1968). In addition, between 1950 and 1965, medical care prices rose twice as fast as consumer prices overall, and consumer expenditures for health care went from $8.5 billion to $28.1 billion (Gorham, 1968). The late 1950s and early 1960s saw persistent efforts to expand state and federal government programs to cover medical expenses for the elderly, poor, and other groups. The first legislation to provide health insurance for Social Security beneficiaries was introduced in 1952, and a national program for certain aged and other poor individuals was passed in 1960. The adoption of a more comprehensive national program for the elderly and a state-federal plan for certain low-income groups took another five years. Medicare The events leading up to the passage of Medicare, Title 18 of the Social Security Act, are well documented (Feingold, 1966; Harris, 1969; Somers and Somers, 1967, 1977a, 1977b; Anderson, 1968; Marmor, 1973; Starr, 1982). The legislation, which was passed in 1965 (to take effect in July 1966), reflected the bitter political battles and varied compromises that preceded final agreement. In 1972, Medicare was extended to disabled individuals and certain others (who now constitute about 10 percent of all beneficiaries). In 1982, employers who offered a health plan were required to cover workers aged 65 to 69. For both practical and political reasons, the program reflected and built on structures and practices developed in the private insurance sector. In its design and implementation, Medicare continued the division between hospital and physician services coverage that had accompanied the growth of Blue Cross and Blue Shield. It maintained free choice by beneficiaries of physician and hospital. It essentially took the hospital insurance and cost reimbursement approach from Blue Cross (except that it included a deductible for hospital care) and adapted the medical insurance approach from

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Employment and Health Benefits: A Connection at Risk commercial insurers. However, Medicare adapted from Blue Shield the participating physician concept and the method for paying physicians based on reasonable charges.22  Participating physicians had to agree to accept these payments as payments in full, but physicians could choose not to participate and bill patients for the balance. In addition, the original Medicare legislation had special provisions allowing Medicare beneficiaries to enroll in prepaid group practices (but not on a capitated basis). Congress did not follow the suggestion of a Kaiser official that the program be structured along the lines of the Federal Employees Health Benefits Program (Somers and Somers, 1972, reprinted in Somers and Somers, 1977b). For program administration, Medicare used private organizations, known as intermediaries for Part A and carriers for Part B. On the hospital, or Part A, side, most of the intermediaries were Blue Cross plans. On the Part B side, carriers were initially split about 50-50 between commercial insurers and Blue Shield plans, although the Blue Shield share has since grown. Payment for Part A services relies on payroll taxes paid by employers and employees and deductibles and other expenses borne by beneficiaries using services. Part B, which is a voluntary but still near-universal program, is financed through beneficiary premiums (to cover 25 percent of program costs) and general revenues (to cover the other 75 percent). Enrollments in Medicare Part A grew from 19.5 million in 1967 to 33.1 million in 1989; Part B enrollments grew from 17.9 to 32.1 million in the same period (HIAA, 1991b). Total spending for Part A and Part B has gone from $3.1 billion in 1967 to $94.3 billion in 1989. Real spending per beneficiary (in 1987 dollars) rose from $939 in 1970 to $2,671 in 1988 (CBO, 1991b). As is described in the next chapter, many elderly individuals receive additional coverage from former employers. Medicaid The Medicaid program, created at the same time as Medicare, did not build on the social insurance principles that guided the latter program. Rather, it continued the charity care approach of its predecessor, the 1960 KerrMills Act (Marmor, 1973; Starr, 1982; Stevens, 1989). 22   This general approach was first experimented with by the Blue Shield plan in Wisconsin in 1954 and spread rather slowly to other plans until labor unions began pushing the method in the 1960s and Medicare gave the method a further boost (Showstack et al., 1979). Simply described, Medicare would pay the physician whichever charge was lowest: the actual charge for a service to a Medicare beneficiary, that physician's usual charge for the service, or the prevailing fee for all physicians providing the service in the same geographic area. The major alternatives at the time (for fee-for-service practitioners) were payment according to a fixed schedule of fees or payment of a percentage of actual charges.

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Employment and Health Benefits: A Connection at Risk Title 19 of the Social Security Act created a complex program that was to be (1) financed by federal and state funds, (2) aimed primarily at poor individuals who were eligible for certain other welfare benefits, in particular, Aid to Families with Dependent Children, and (3) administered by the states under federal rules. These rules provided considerable latitude for states to determine who would be eligible, what services would be covered, and how much providers would be paid. The result has been substantial state-to-state variation (PPRC, 1990). For example, states have varied in the extent to which their Medicaid programs cover low-income workers and their families. For a welfare recipient, employment often means an end to Medicaid without the beginning of employment-based coverage, although federal requirements provide some exceptions. Overall, Medicaid generally has covered less than half of the poor (that is, those with incomes below the federally defined poverty level). The 1965 law provided that federal financing for Medicaid, which comes from general revenues, would be dispensed to states on a matching basis related to state per capita income and claims submitted by states.23 Today, the federal contribution to program expenditures constitutes about 56 percent of the total, but the share varies from 50 to nearly 80 percent of the total for individual states (GAO, 1991c). In 1972, Medicaid covered about 17.6 million people, versus 25 million individuals in 1989, but total program costs grew from $6.3 to $64.9 billion during the same period (HIAA, 1991b; EBRI, 1992a). Real payments per user (1990 dollars) rose from $1,200 in 1975 to $2,600 in 1990 and ranged from $6,700 per user for the 3.2 million aged participants to $800 per user for the 11.2 million children from low-income families (CBO, 1992c). In 1990, Medicaid was the second-largest component of state spending and was increasing faster and less predictably than other costs. At 12 percent of total state spending, it was exceeded only by spending on elementary and secondary education at 23 percent (GAO, 1991c, 1992a). In 1989, 49 governors asked Congress for a two-year moratorium on federally mandated expansions of Medicaid eligibility and services. National Health Insurance Revisited In the 1970s, some kind of national health insurance program was widely believed to be imminent (Starr, 1982). A 1977 summary by Herman and Anne Somers listed four basic categories of proposals (Table 2.5). The greatest opportunity for action came in 1974, when the Nixon ad- 23   States may require local governments to cover up to 60 percent of program costs, but only 14 states did so in 1990, and the local burden was significant in only 3 states (PPRC, 1990).

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Employment and Health Benefits: A Connection at Risk TABLE 2.5 Major Categories of "National Health Insurance" Proposals in the Early 1970s Tax Credits • Purchase of private insurance subsidized through tax credits for premiums paid for insurance meeting established standards. Employer Mandate • Employers required to provide an approved level of private insurance for full-time employees and their dependents. • Premiums for the poor and unemployed subsidized by the government. Expanded Medicare-Type Program • Private insurers act as administrative agents for universal national health plan financed by payroll and other taxes. Fully Public Program • National government directly administers universal health plan financed by payroll and other taxes.   SOURCE: Adapted from Somers and Somers, 1977a. ministration and congressional leaders (in particular, Senator Kennedy and Representative Mills) appeared willing to compromise on a broad national health insurance program. They proposed private insurance for workers and their families and public coverage for others. Labor and some other liberal groups still favored a fully public program, but organized medicine and traditional opponents of government action appeared to have accepted that the time for a comprehensive national health program had come. Nevertheless, none of the major proposals introduced in the 1970s were successful. At the time of writing this report, just before the 1992 presidential election, health insurance had appeared as a noteworthy campaign issue for the first time since 1976. Although they vary in specifics, many current proposals still fit the basic categories identified in Table 2.5. Even one missing category, what now goes under the rubric managed competition, had been quite clearly described (and endorsed) by Somers and Somers as early as 1971. After calling for "pluralistic and regulated competition" and "consumer options . . . [among carriers approved by a national board] . . . on an informed and meaningful basis," they warned that the policy debate threatened to degenerate into "doctrinaire position-taking'' among those attached to "old ideologies" that pitted "public" against "private" strategies (pp. 193, 198, 200). In fact, the 1970s and 1980s did see a debate that was framed in terms of market versus regulatory strategies (as described further in Chapter 6), and the same rhetoric continues to be heard in the 1990s.

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Employment and Health Benefits: A Connection at Risk FEDERAL REGULATION AND THE EMPLOYER'S GROWING ROLE Federal and State Roles Before 1974 The federal structure of the U.S. political system has produced a particularly complex and uneven mix of state and national regulation of health insurance and related matters. Before 1974, states generally regulated private health insurance, whether it was individual or employment-based, insured or self-insured. State insurance regulation began in the mid-1800s and was upheld by a Supreme Court decision in 1868, which ruled that insurance contracts were not part of interstate commerce and therefore were subject to state not federal regulation. In 1944 the Court reversed its decision, holding that insurance transactions did involve interstate commerce and were subject to federal antitrust and other laws. This decision, in turn, was overruled in 1945, when Congress passed the McCarran-Ferguson Act. The act returned to the states many regulatory powers but left the option of national regulation of insurance if states did not act. In order to promote systematic state action and avoid federal regulation, the National Association of Insurance Commissioners was formed to assist in the development and passage of model state legislation. Until the 1970s the national government largely confined its attention to employment-based health benefits to two policy issues: collective bargaining and taxation. Faced with rising Medicare and Medicaid costs in the 1970s, the federal government instituted an array of cost management initiatives, including federal wage-price controls, health resource planning, HMO promotion, and quality and utilization review of health care services (see Chapter 6 for a discussion of these programs). With the exception of the HMO Act of 1973, which mandated that most employers offer their employees a federally qualified HMO if one was available, these initiatives did not touch employment-based health benefits very directly. (Legislation adopted in 1988 calls for the HMO mandate provision to expire in 1995.) The Employee Retirement Income Security Act of 1974 In 1974 the division of federal and state regulatory authority with respect to employee benefits changed fundamentally with the passage of the Employee Retirement Income Security Act (ERISA). Since then, the relevance of state regulation to employment-based health plans has declined dramatically—without any significant expansion in substantive federal regulation of plan operations and characteristics. ERISA was aimed primarily at private employer pension plans, and most of its provisions and implementing regulations are directed at such

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Employment and Health Benefits: A Connection at Risk pension plans with little explicit attention to health plans. As interpreted by the courts over the years since its passage, however, ERISA has preempted an increasing number of state regulations affecting employment-based health plans (Appendix B; Moses, 1992). Despite some pressure to do so, Congress has refused to enact legislation that would overrule these interpretations. States can indirectly reach some employers through their regulation of insured health plans, including insured HMO plans, but the group of insured employers has grown smaller every year as more employers—including quite small employers—have seen the advantages of self-insuring to avoid such regulation. Multistate employers are free to establish uniform health benefit programs across state lines and no longer have to modify their programs to conform to the myriad different details of state laws. For self-insured employers the major regulatory consequences of ERISA are that such plans are exempt from several requirements: state taxes on insurance premiums; state mandates that certain types of benefits be provided; state limits on certain kinds of utilization management and provider contracting arrangements; solvency and prefunding requirements; defined claims settlement procedures; state law claims for various kinds of damages; and mandatory participation in state risk pools or uncompensated care plans. The last protection is now one of the most controversial, as many states try to maintain or establish these kinds of programs. A recent federal court decision in a case brought by 14 union health and welfare plans held that ERISA precluded the state from requiring such plans to pay hospital bills that included subsidies for uncompensated and undercompensated care (United Wire Health and Welfare Fund v. Morristown Memorial Hospital, 15 EBC 1625 [1992]) (Firshein, 1992b). In addition, ERISA has been interpreted as exempting those administering claims for employee benefit plans from punitive damages for bad faith denials of claims. Further, in a case decided in June 1992, a federal appeals court held that ERISA precluded a malpractice action against a company that provided utilization review services to an ERISA-covered plan (Corcoran v. United Health Care, Inc. and Blue Cross and Blue Shield of Alabama, 1992 U.S. App. LEXIS 14621 [5th Cir., June 26, 1992]). (See Chapter 4 for further discussion of the legal liability of employers.) Although ERISA precludes state regulation of self-insured employer-sponsored health benefits, it does not replace diverse state policies with an equivalent set of consistent national standards. The requirements it imposes on employers are quite limited. They primarily involve information reporting and disclosure, prudent exercise of fiduciary responsibilities, limits on disproportionate benefits for highly compensated employees, and (since 1985) continued coverage for certain former workers and others. There is no provision for waivers from ERISA requirements, and only one state, Hawaii, has obtained a statutory waiver.

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Employment and Health Benefits: A Connection at Risk The point that ERISA preempts state regulation without substituting explicit federal regulation of some basic dimensions of health benefit plans can be illustrated with several specific examples, which are discussed further in Appendix B. Unlike many or all state laws, ERISA sets no solvency, reserve, funding, financial management, or backup insurance requirements for health plans to protect employees in the event of employer bankruptcy; specifies no standards for health coverage or minimum benefits; establishes no requirements that certain categories of employees or family members be generally eligible for coverage (except for the continued coverage requirements described below); and contains no prohibitions against unilateral reduction or termination of benefits by an employer during the plan year nor any limits on medical underwriting practices such as exclusions of coverage for preexisting conditions. With respect to this last point, although ERISA did not set funding and vesting requirements for health benefit plans as it did for pension plans, other statutes and the general law of contracts may limit employers' freedom to reduce or terminate benefits in some cases. For example, employers may need to prove that their right to terminate retiree benefits was specifically stated and widely known to employees (EBRI, 1991d). This constraint is particularly significant for employers considering their options given recent nongovernmental rules established by the Financial Accounting Standards Board (FASB). These rules require that benefits promised to retirees be recognized as liabilities on a firm's financial statements. (See Chapter 3 for further discussion.) ERISA did establish somewhat more extensive regulatory provisions for one type of employment-based health benefits involving multiple employers, but the results have not been satisfactory to many (CRS, 1988b; McLeod and Geisel, 1992; National Health Policy Forum, 1992; U.S. Senate Committee on Governmental Affairs, 1992a). Multiple employer plans were originally defined as plans to which more than one employer contributes but which are not collectively bargained. Then in 1982, Congress redefined this category as multiple employer welfare arrangements (MEWAs), and made such plans subject to special regulations intended to control abuses fostered by the lack of applicable federal or state regulation. Fully insured MEWAs are subject to direct state insurance regulation related to the adequacy of contribution and reserve levels. MEWAs that are not fully insured are subject to all state insurance regulations, to the extent that they are not inconsistent with ERISA. Abuses and outright fraud by some third parties marketing MEWAs have led to calls for further legislation to strengthen regulation of such plans at the state or federal level or both.

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Employment and Health Benefits: A Connection at Risk Further complicating the regulatory picture are multiemployer plans, which, as defined by statute, are plans to which more than one employer contributes pursuant to collective bargaining agreements. They generally have joint labor-management boards, are regulated under the 1947 Taft-Hartley Act, and are explicitly excluded from coverage under the ERISA amendments related to multiple employer welfare arrangements. Federal laws enacted since ERISA have imposed a limited number of mandates on employers. The most important emerged from the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1985. That act requires employers with 20 or more employees who offer health benefits to offer continued coverage to most former employees, their dependents, and certain others for 18 or 36 months or until coverage under another plan begins.24 Employers can charge no more than 102 percent of the average cost to the employer of providing coverage to all its employees.25 An earlier federal law, the Tax Equity and Fiscal Responsibility Act of 1982, requires employers with 20 or more workers to cover certain employees (those aged 65 to 69, the disabled, and those with end-stage renal disease) who would otherwise be eligible for Medicare coverage. Overall, ERISA gave a powerful boost to employer discretion and involvement in the management of health benefits. It diminished the position and influence of states and insurers and eliminated some protections for insured individuals but provided little in the way of explicit national standards for employee health benefits. As states' concern about the uninsured and the financial problems of health care institutions providing uncompensated care has grown, ERISA has also limited states' efforts to develop state risk pools, set minimum standards for certain kinds of health benefit programs, and act generally in areas in which the federal government has not taken the initiative. CONCLUSION Although the link between occupation or workplace and assistance with the costs of illness dates back to the last century and before, it has generally been tenuous and limited by its voluntary character and by the limited financial resources of those involved. In most countries the result has been the gradual mandating by governments of compulsory, near-universal, publicly subsidized coverage. These mandates have sometimes built on work-related insurance organizations and employer and employee deductions to 24   COBRA does not require a former employee or other eligible individual to accept coverage under another plan, for example, a plan available from a new employer. 25   One recent study indicated that claims costs for those who elect COBRA coverage are 120 percent of the cost for the non-COBRA group (A. Foster Higgins, 1992).

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Employment and Health Benefits: A Connection at Risk cover "premiums," but employers have been left with relatively little discretion regarding the details of health benefit programs and with limited involvement in health care cost management. The exception to this pattern is the United States, where voluntary private action has managed—with some assistance from facilitating national legislation—to extend coverage to the majority of the nonelderly population. Although the concept of workers' compensation had become widely accepted and broadly accommodated in state laws by the second decade of the century and other social insurance concepts were adopted at the national level during the 1930s, insurance for medical care expenses did not follow these precedents. Opposition by important interests outside and inside government to an expanded government role has limited public health insurance programs to the elderly and a segment of the poor. Millions of individuals are not covered by either public or private programs. The next four chapters of this report describe the current status of employment-based health benefits and discuss developments over the last two decades. Among the key features cited are the extensive involvement by business (primarily large employers) in the design of health plans and efforts to influence the delivery, price, and overall cost of health care; significant responsibilities and administrative complexity for employers, employees, health care providers, and public officials resulting from the expansion and diversity of employers' efforts to manage their health benefit programs; troublesome segmentation of high-and low-cost or high-and low-risk individuals into different insurance pools and growing debate about what constitutes an equitable spreading of risk for medical care expenses; continued escalation in medical care expenditures and uncertainty about the value of this spending despite many efforts to contain medical care prices, limit unnecessary or marginally beneficial use of health care services, and otherwise control costs; and persistent controversy about the merits of public, private, or mixed strategies for achieving a more satisfactory allocation of resources for health care.