Evolution of the Health Insurance Market

Introduction

If you needed medical care back in the 1930s, you would directly pay the physician the cost for their services and go about your day. Today, the payments for that same care may pass through private insurers, employer-sponsored health insurance plans, pharmacy benefit managers, and even the federal government.

Your payments and amount of care received may also be determined by other complicated cost-controlling measures such as deductibles, co-insurance, co-payments, health maintenance organizations, and preferred provider organizations.

Overall, health care payments and the insurance system look nothing like they did a century ago. Americans are spending more than they ever have before on health care, yet proportionally paying the least they ever have for expenses out of their own pockets.

Looking through the history of the health care insurance industry can help us better understand how we got to where we are today by showing how different reforms and payment systems have affected costs, coverage, and the provision of health care.

One thing is clear: the transformation of the American health insurance system did not reduce costs. Rather, it changed who pays, when they pay, and how costs are hidden.

The 1930s and 1940s

The 1930s were still very much dominated by a direct-payment system for health care. For fiscal year 1934-35, only 4.2% of gross national product was due to health care expenditures, 81.3% of which was private spending.

Very few people had private health insurance plans. It is estimated that approximately 1.5 million people were on some form of health insurance plan or prepayment arrangement. This was just over 1% of the population at the time. This means the vast majority of Americans were financing their medical costs completely out-of-pocket.

There was also no nationalized health care insurance or subsidies in the 1930s. Franklin D. Roosevelt attempted to include national health insurance in the Social Security Act of 1935, but removed it due to strong opposition.

However, the 1930s were still a notable time period, as it is when the health insurance industry began to form. What we now know as Blue Cross and Blue Shield sprung up under the names of the Baylor Plan and California Physicians’ Services, respectively.

The Baylor Plan was initially created in 1929 by an administrator at Baylor University Hospital to give free hospital services for 21 days in exchange for a 50-cent monthly premium. This model quickly spread, and by 1933, 26 such hospital service plans were in operation.

The California Physicians’ Service was created in 1939 to help patients cover physician services. They worked by providing a set dollar amount to the patient for each covered medical event. The patient was responsible for directly paying the physician.

Yet, perhaps one of the most consequential effects on the American health insurance industry stemmed from wage controls put forth by the Roosevelt administration in 1941. The wage controls triggered a frenzy of employers increasing benefits via employer-sponsored health care in order to attract more workers and stay competitive in the labor market.

Due to the newfound volume of employer-sponsored health benefits, the National War Labor Board was forced to rule on the tax status of employer-sponsored health insurance. In 1943, the board issued a ruling that allowed employer-sponsored health insurance to be tax-exempt, largely based on the belief that it was a negligible cost.

As it turns out, employer-sponsored health care would not be a negligible cost for long, and it was largely due to this ruling. The creation of employer-sponsored health insurance plans exploded, permanently tying employment to health care coverage.

By 1940, the percentage of Americans with some form of health insurance was still just 9%. However, the tax ruling, along with the creation of Blue Cross and Blue Shield plans, laid the groundwork for private health insurance plans, not national health insurance plans, to dominate the health care market for the next couple of decades.

The 1950s and 1960s

In 1954, Congress codified the employer-sponsored health insurance tax exemption into law, while simultaneously removing previous caps on the percentage of salary that could be used as tax-exempt health care coverage.

This furthered the growth of private health insurance coverage via employers, and by 1960, nearly two-thirds of the country had health insurance.

Blue Cross and Blue Shield plans were also rapidly growing. In the 1960s, the Blue Cross Commission parted ways with the AHA and became the Blue Cross Association.

Also in the 1960s, many commercial insurers switched from community-based rating, which calculates premiums as though everyone is part of one risk pool, to experience rating, which means giving enrollees different premium prices based on their health risks.

Due to immense competition from commercial insurers, Blue Cross and Blue Shield plans also had to make the switch from community-based rating to experience-based rating. This meant low-risk, healthy Americans had extensive options for low-cost health insurance plans.

Moreover, Democrats were elected in a landslide election in 1964, gaining control of the House, Senate, and White House. With that, Democrats were finally ready to materialize their goal of creating a nationalized health care system.

This led to the biggest change in the American health care system: the introduction of Medicare and Medicaid. Both Medicare and Medicaid were signed into law by Lyndon B. Johnson through the Social Security Amendments of 1965.

Medicare was initially only two parts: Part A and Part B. Medicare Part A was meant to cover hospital services, along with some nursing home expenses, for America’s senior citizens, funded through a compulsory payroll tax.

Medicare Part B, on the other hand, was voluntary. It was funded through general tax revenues and premiums paid by Medicare enrollees and used to pay for physician and outpatient services for senior citizens. The eligibility for both Medicare Part A and Part B was tied to Social Security enrollment.

The enactment of Medicaid was a part of President Johnson’s “War on Poverty” initiative. It was a federal-state partnership program that gave free health care coverage to low-income Americans who also qualified for cash welfare.

Medicare and Medicaid had vast effects on the insurance market and the health care market more broadly.

There was an explosion of a new kind of socialized health insurance, with many low-income Americans shifting from being uninsured to being Medicare or Medicaid enrollees. Health expenditures as a percent of GNP began to rapidly rise, and so did government health care spending.

According to the Mercatus Center, consumers' out-of-pocket expenditures as a percent of total health expenditures peaked in 1965 at 43%. In each subsequent year following 1965, national health care expenditures increased by an average of 9.8% per year, and consumer out-of-pocket health care expenditures increased by an average of 6.7% per year.

Moreover, both Medicare and Medicaid spending increased by an average of more than 15% per year following their enactment in 1965.

The percentage of Americans who were uninsured dropped, particularly among the elderly. Enrollment continued to grow for both programs, increasing from 20 million beneficiaries in 1968 to nearly 68 million beneficiaries in Medicare and 71 million in Medicaid today.

It is also worth noting that employer-sponsored insurance still remained strong, as many new Medicare and Medicaid enrollees were previously uninsured, not on any kind of employer-sponsored insurance plan.

1970s and 1980s

The 1970s and 1980s were marred by rapidly rising premiums. Health care spending tripled from 1972 to 1982, increasing from $94 billion to $322 billion. Out-of-pocket expenditures also rapidly increased from $155 per capita in 1970 to $488 by 1989.

A large part of this increased spending was due to medical technological advancements and the higher costs associated with them.

However, there were other things changing during these two decades as well. First, Blue Cross and Blue Shield merged in 1977, dominating what became an even more consolidated insurer market.

Another important piece of health insurance legislation was passed in 1974, known as the Employee Retirement Income Security Act (ERISA). ERISA restricted the ability of states to make laws that regulated employee welfare benefits, including employer-sponsored health insurance plans.

If an employer provides their insurance through a traditional health insurance product or HMO, then they would still be subject to state insurance regulations. However, if an employer chose to self-insure, those regulations would be waived.

This resulted in many employers choosing to go self-insured for their employee health insurance plans. From 1981 to 1985, the percentage of mid-to-large-sized employers that were self-insured increased from 21% to 42%.

However, as budgetary pressures began to increase throughout the 1980s, conventional insurance began to be replaced by HMOs. HMOs, or Health Maintenance Organizations, are a merger of a provider and insurer that only allows enrollees to select from physicians who are in-network with the HMO. They also often emphasize preventative care. The main goal of this was to contain costs and limit overall medical care use.

In 1988, 71% of Americans with employer-sponsored health insurance had conventional health insurance plans. However, due to the rise of HMOs, Preferred Provider Organizations (PPOs), and high-deductible plans, the number of workers with conventional health insurance plans dropped to less than 1% in 2012.

Other cost control measures became very popular in health insurance plans in the 1980s, including large deductibles, co-payments, and co-insurance. According to CMS, between 1977 and 1987, the percentage of employer-sponsored plans with less than a 20% coinsurance rate and no deductible fell from 7.8% to 1.7%. Moreover, the percentage of plans with deductibles and a 20% co-insurance rate or more increased from 60.1% to 75.4%.

Furthermore, Medicaid was expanded in 1986 by the Sixth Omnibus Budget Reconciliation Act (SOBRA). Medicaid would now cover vulnerable groups, such as infants and pregnant women, up to 100% of the federal poverty line.

It is clear that the 1970s and 1980s were a tumultuous time for the health insurance market. It was one of the first times that health care became an immense budgetary pressure for both American households and the federal government.

Health expenditures as a percent of GDP climbed to 8.9% in 1980. This was way up from only 5% in 1960. Moreover, overall spending on health care more than tripled from 1973 to 1983, growing from $103 billion to $355 billion.

The government took on a large portion of these increases, growing their contribution from only 24.5% in 1960 of total health care expenditures to 42.2% of total health care expenditures in 1980. Additionally, Medicare and Medicaid spending alone grew from accounting for 16.4% of total national health expenditures in 1970 to 29% in 1990.

The 1990s

The 1990s were initially a better decade in terms of health care costs. Due to the robust economic growth and the ability of managed care to control costs, health insurance premiums were actually declining in real terms.

In 1988, 73% of workers on employer-sponsored health insurance plans still had conventional coverage. By 1999, this number dropped to 10%, with 28% of workers being a part of an HMO and 39% being a part of an PPO.

This increase in managed care led to a reduction in the annual growth rate of health care prices from 8.8% in 1989 to 1.9% in 1998.

However, eventually public dissatisfaction with the restrictions on care grew, which led to lawsuits and regulation from Congress, stunting the growth and negotiation power of managed care organizations. Therefore, medical prices and health insurance premiums began to increase again, accelerating national expenditures on health care.

Another notable change to the health insurance landscape was the introduction of the Children’s Health Insurance Program (CHIP) in 1997. CHIPS provided federal funding for states to cover pregnant women and children whose income was above 100% of the federal poverty line.

Real out-of-pocket spending per capita fell, while government expenditures continued to climb, largely due to the rapidly rising costs of the Medicaid program.

21st Century

The 21st century experienced some of the biggest government-sponsored reforms to the health care industry since the passage of Medicare and Medicaid in 1965.

First, Medicare added two more parts, Medicare Part C and Part D. Medicare Part C was established in 1997 as a part of the Balanced Budget Act of 1997. It was later renamed to Medicare Advantage in 2003.

Medicare Advantage allows Medicare enrollees to obtain private coverage that is approved by Medicare. A Medicare Advantage plan will cover Medicare Parts A, B, and typically D. Medicare then pays a fixed amount to the insurance company offering the enrollee coverage for their care.

Medicare Advantage has been rapidly growing throughout the 21st century, increasing from 26% of total Medicare enrollees in 2012 to 42% of enrollees in 2021. This increase represents the growing interconnectedness of private health insurers and government-run programs.

Medicare Part D was passed in 2003 under the Medicare Prescription Drug, Improvement, and Modernization Act of 2003. It was implemented starting in 2006. Medicare Part D had a huge impact on the health care coverage market, as it allowed Medicare enrollees to obtain voluntary prescription drug coverage.

Medicare Parts C and D, like any government health care coverage, decreased the proportion that people paid for health care out-of-pocket.

At the same time, rapidly rising health costs in the 21st century prompted a new approach to insurance coverage: Consumer-Directed Health Plans (CDHP). CDPHs are high-deductible health plans paired with health savings accounts, allowing consumers to have minimal coverage with low premiums.

These plans became increasingly popular throughout this century, growing from 7.5% of commercially insured Americans in 2008 to 31.9% of commercially insured Americans in 2017.

However, the most significant reform of the modern era was the Patient Protection and Affordable Care Act (ACA), passed in 2010. The ACA had vast impacts on coverage, costs, and even employer-sponsored health insurance.

The ACA instituted a new slate of mandates and regulations on the insurance market, including modified community-based rating, minimum coverage standards, medical-loss ratio requirements, and mandated insurance coverage.

In addition, the ACA created the Marketplace, which allowed individuals to shop and compare private health insurance plans. More importantly, Americans under 400% of the federal poverty line could receive subsidies toward their private insurance plans through the ACA Marketplace.

The ACA also included a major expansion of Medicaid, mandating states to expand eligibility to up to 138% of the federal poverty line. However, following a Supreme Court ruling, the expansion became optional for states. 10 states, including Wisconsin, have chosen not to expand their Medicaid programs.

So, how did the new policies and government regulations of the ACA affect the health insurance landscape? A lot of spending was shifted over to the government. In just 2014 alone, the first year of full implementation of the ACA, federal spending on health care grew 11%. Moreover, government spending as a share of total health care expenditures increased to 46% in 2024.

It is important to note that while the ACA had the most drastic effect on the individual market and marketplace plans, it also had vast effects on employer-sponsored insurance plans. The ACA created an employer mandate, which required large-group employers to offer qualified and comprehensive health insurance coverage or face a penalty.

Insurance premiums also skyrocketed after the initial implementation of the ACA due to higher compliance costs and market consolidation associated with all of the new regulations. From just the first few years of the ACA, 2013 to 2017, insurance premiums increased by an average of 105% in the individual market. The increase was 93% in Wisconsin. Several states even saw their premiums triple after the ACA’s full rollout.

Another interesting trend from the 21st century was the decline in employer-sponsored health insurance. Despite the employer mandate from the ACA, the percentage of employers offering health benefits reached a near-record low in 2023, just 46.3%.

This has largely been due to small-group employers, who are not subject to the employer mandate, choosing to no longer offer coverage due to the cost of premiums rising faster than revenue.

Conclusion

Over the past century, the American health care system has rapidly transformed from one of simple direct payment to a complex network of insurers, managed care, government programs, and employers. While each subsequently lowered out-of-pocket costs, it did not actually lower the price of health care. Rather, costs have simply been shifted to third-party payers.

By understanding the historical evolution of American health insurance, we can see that the cost-shifting of health care has failed to address the root of the problem: rapidly increasing health care costs. Moreover, knowing the history of health insurance can aid us in evaluating modern health care policy debates and, hopefully, think of strong policy solutions going forward.