Health Insurance: A Primer

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People buy insurance to protect themselves against the possibility of financial loss in the future.
Such losses may be due to a motor vehicle collision, natural disaster, or other circumstance. For
patients, financial losses may result from the use of health care services. Health insurance then
provides protection against the possibility of financial loss due to high health care expenses. Also,
people do not know ahead of time exactly what their health care expenses will be, so paying for
health insurance on a regular basis helps smooth out their out-of-pocket spending.
While health coverage continues to be mostly a private enterprise in this country, government ^th
plays an increasingly significant role. Especially during the latter half of the 20 century, the
government both initiated and responded to dynamics in medicine, the economy, and the
workplace through legislation and public policies. For example, the Internal Revenue System
clarified that employer contributions to employee health benefits are exempt from taxation, which
encouraged the growth of employment-based health coverage. Given the frequent introduction of
legislation aimed at modifying or building on the current health insurance system, understanding
the potential impact of such proposals requires a working knowledge of how health insurance is
designed, provided, purchased, and regulated. This report provides background information about
these topics.
Individuals and families without health coverage are more likely than those with coverage to
forgo needed health care, which often leads to worse health outcomes and the need for expensive
medical treatment. Since uninsured persons are more likely to be poor than insured persons, the
uninsured are less able to afford the health care they need. Uninsurance can lead to health care
access problems for communities, such as overcrowding in emergency rooms. Taxpayers and the
nation as a whole are affected through increased taxes and health care prices to cover the
uncompensated care expenses of uninsured persons.
Americans obtain health insurance in different settings and through a variety of methods. People
may get health coverage through the private sector, or from a publicly funded program.
Consumers may purchase health insurance on their own, as part of an employee group, or through
a trade or professional association. However, approximately 47 million Americans did not have
health coverage for the entire year of 2006.
Health insurance benefits are delivered and financed under different systems. The factors that
distinguish one delivery system from another are many, including how health care is financed,
how much access to providers and services is controlled, and how much authority the enrollee has
to design her/his health plan. To illustrate, managed care is characterized by predetermined
restrictions on accessing services and providers, whereas individual decision-making regarding
use of health benefits is a hallmark of consumer driven health care, such as health savings
accounts. As economic conditions change, a specific delivery system may gain or lose the interest
of affected parties. This report will be updated periodically.

Introduc tion ..................................................................................................................................... 1
What Is Health Insurance?...............................................................................................................1
Definitions and Principles.........................................................................................................1
Uneven Distribution of Health Care Expenses...................................................................2
Risk Pool and Rate Setting.................................................................................................2
Risk Pool Composition and Adverse Selection...................................................................3
Group Market, Nongroup Market, and Medical Underwriting...........................................3
Fully Insured vs. Self-Insured Plans...................................................................................4
Self-only vs. Family Coverage...........................................................................................4
Administrative Expenses....................................................................................................5
Tax Preference...........................................................................................................................5
Health Insurance Regulation.....................................................................................................5
Responsibility of the States.................................................................................................6
Key Federal Statutes...........................................................................................................6
Health Insurance Premiums......................................................................................................7
Why Is Health Insurance Considered Important?............................................................................7
Where Do People Get Health Insurance?........................................................................................8
Employer-Sponsored Insurance................................................................................................9
Adva ntages ........................................................................................................................ 10
Disadvanta ge s .................................................................................................................. .10
Large vs. Small Groups......................................................................................................11
Public Programs.......................................................................................................................11
Medicare ............................................................................................................................ 11
Medicaid and the State Children’s Health Insurance Program (SCHIP)..........................12
Individual Health Insurance....................................................................................................12
State High Risk Pools..............................................................................................................13
The Uninsured.........................................................................................................................14
How Are Private Health Benefits Delivered And Financed?.........................................................15
Indemnity (Traditional) Insurance...........................................................................................15
Managed Care.........................................................................................................................15
Consumer Driven Health Care................................................................................................16
Table 1. Health Insurance Coverage for All Persons, by Type of Insurance, 2006.........................9
Author Contact Information..........................................................................................................17

As health insurance coverage evolved from an uncommon benefit to a routine one, government’s
role in subsidizing and regulating that coverage also changed. Although health coverage
continues to be mostly a private enterprise in this country, public entities play an increasingly
significant role.
Government’s involvement in health coverage expanded dramatically in the latter half of the 20^th
century:
• A long-standing rule issued by the Internal Revenue Service (IRS) stated that an
employer’s contributions to employment-based health insurance could not be
included in an employee’s gross income for tax purposes (Internal Revenue
Code, Section 106). This ruling helped spur the growth of employer-sponsored
health benefits. The IRS also stated separately that employers could deduct such
contributions as part of business expenses.
• Advances in medicine led to escalating consumer demand for newer, better
treatments. At the same time, the cost of some treatments increased, which was
especially problematic for certain groups of consumers who lacked health
coverage. This led to government efforts to assist health care consumers in ¹
paying for medical services through social insurance programs.
• More and more employees began to work for more than one employer over their
lifetimes. Government was called on to address a problem many workers faced:
keeping health coverage as workers moved from job to job.
Given the frequent introduction of legislation aimed at modifying or building on the current
health insurance system, understanding the potential impact of such proposals requires a working
knowledge of how health insurance is designed, provided, purchased, and regulated. This report
provides background information about these topics.

People buy insurance to protect themselves against the possibility of financial loss in the future.
Such losses may be due to a motor vehicle collision, natural disaster, or other circumstance. For
patients, financial losses may result from the use of health care services. Health insurance then
provides protection against the possibility of financial loss due to high health care expenses. Also,
people do not know ahead of time exactly what their health care expenses will be, so paying for
health insurance on a regular basis helps smooth out their out-of-pocket spending.

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The concept underlying insurance is “risk” (i.e., the likelihood and magnitude of financial loss).
In any type of insurance arrangement, all parties seek to minimize their own risk. In health
insurance, consumers and insurers approach the management of insurance risk differently. From
the consumer’s point of view, a person (or family) buys health insurance for protection against
financial losses resulting from the future use of medical care. From the insurer’s point of view, it
employs a variety of methods to minimize the risk it takes on when providing health coverage to
consumers, to assure that it operates a profitable business. One method is to cover only those
expenses arising from a pre-defined set of services (generally called “covered” services). Another
method for limiting risk is to encourage healthier people to obtain health coverage, presumably
because healthier people would not need as many medical services as sicker people, leading to
fewer claims that the insurer would have to cover.
While the methods employed by an insurer differ from those of a consumer, each has the same
goal: to minimize risk in an uncertain future. It is this uncertainty of the future and risk of
financial loss which form the context for insurance, and the strategies to make financial loss more
predictable and manageable which drive insurance arrangements.
In health care, a minority of consumers are responsible for a majority of expenses. According to a
longitudinal study conducted by the federal Agency for Healthcare Research and Quality, 5% of
the population accounted for about half of all health expenditures in 2002, and 10% of the ²
population accounted for nearly two-thirds of expenditures in the same year. Given the
unevenness of health care spending and the improbability of identifying all of the highest
spenders before they use medical services, insurers employ various strategies in order to
minimize the risk they take on.
A function of insurance is to spread risk across a group of people. This is achieved in health
insurance when people contribute to a common pool (“risk pool”) an amount at least equal to the
expected cost resulting from use of covered services by the group as a whole. In this way, the
actual costs of health services used by a few people are spread over the entire group. This is the
reason why insuring larger groups is considered less risky—the more individuals participating in
a risk pool, the less likely that the serious medical experiences of one or a few persons will result
in catastrophic financial loss for the entire pool.
An insurer calculates and charges a rate (i.e., a “premium”) in order to finance the health
coverage it provides. The premium reflects several factors, including the expected cost of claims
for health care use in a year, administrative expenses associated with running the plan, and a
profit margin. If the insurer accurately estimates future costs and sets appropriate premium levels,
then that risk pool has reached equilibrium where premiums paid by healthy persons in the risk
pool help subsidize the higher-than-average costs of less-healthy persons in the pool.

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As noted above, one of the ways insurers attempt to make future costs more predictable is by
spreading the risk of a few high-cost individuals across many people. But the number of people in
a risk pool is not the only significant factor. Equally as important, if not more so, is the
composition of the group.
A consumer’s decision to obtain health coverage is based on a variety of factors, such as
individual health status, estimated need for future medical care, and disposable income.
Consumers with different health conditions, as well as varying degrees of comfort towards risk-
taking, will differ on whether they consider health insurance necessary. This is a circumstance
that insurers will consider when estimating their expenses to cover future health care use. With
this in mind, insurers generally will vary the premiums they charge and the health services they
cover (subject to state and federal statues) in order to attract various segments of the population.
This flexibility in rate setting and benefit determination is particularly important in a competitive
insurance market where insurers try to provide the most attractive rates to increase their market
share.
However, some risk pools do attract a disproportionate share of unhealthy individuals. In part,
this is because individuals generally know more about their own health conditions than anyone
else, including an insurer. Therefore, health care consumers have an advantage over insurers in
terms of knowing the kind and amount of health services they will use, at least in the short- to
mid-term. This “information asymmetry” between what consumers know compared to what
insurers know gives consumers an advantage when looking for health coverage that will meet
their future demand for health care. For example, if a consumer plans on obtaining orthodontic
care in the near future, that consumer will look for a health plan with generous dental benefits.
Information asymmetry is another source of uncertainty that insurers take into account when
developing and pricing insurance products.
When a disproportionate share of unhealthy people make up a risk pool, a phenomenon known as
“adverse selection,” the cost for each person in the pool rises. The higher costs may encourage the
departure of healthier members from the group, and discourage the entrance of other healthy
people, since healthier people may be able to find cheaper coverage elsewhere or decide that
coverage is too costly and become uninsured. In either situation, it leaves an even less healthy
group of people in the risk pool, which again causes the cost to rise for the remaining participants.
If there is no change in this dynamic, the group may experience a “death spiral” as it suffers
substantial adverse selection leading to an increasingly expensive risk pool and possibly
dissolution of the pool altogether. Therefore, despite the consumer’s information advantage, it
does not guarantee access to affordable and adequate health coverage.
Health insurance can be provided to groups of people that are drawn together by an employer or
other organization, such as a trade union. Such groups are generally formed for some purpose
other than obtaining insurance, like employment. When insurance is provided to a group, it is
referred to as “group coverage” or “group insurance.” In the group market, the entity that
purchases health insurance on behalf of a group is referred to as the plan “sponsor.”
Consumers who are not associated with a group can obtain health coverage by purchasing it
directly from an insurer in the individual (or nongroup) insurance market. Insurance carriers in

the nongroup market conduct an exhaustive analysis of each applicant’s insurability. An applicant
usually must provide the insurer with an extensive medical history and often undergo a physical
exam. This information is used by carriers to assess the potential medical claims for each person
by comparing characteristics of the applicant to the loss experience of others with similar
characteristics. Once such an evaluation has been conducted, the carrier decides whether or not to
provide health coverage and determines the terms for coverage. This evaluation and
determination process is referred to as “medical underwriting.”
Medical underwriting is standard practice in the individual insurance market, though a carrier’s
ability to reject applicants or vary the terms of coverage are restricted to some degree by federal
and state requirements. In the group health insurance market, insurers forgo underwriting in the
traditional sense (i.e., reviewing each person’s demographics and medical history). Instead, an
insurer looks at the characteristics of the collective group, such as its claims history, group
demographics, and geographic location. The insurer then charges a premium based on the
analysis of the group’s characteristics. There are exceptions to this for very small groups. For
example, when a firm with only a handful of employees applies for health coverage, the insurer
may choose to review the health conditions of each person in order to establish a premium for the
entire group. Or, the insurer may charge a larger premium due to the larger risk attributed to ³
smaller groups, if permitted under law.
A common distinction made between types of health insurance products is whether they are fully
insured or self-insured. A fully insured health plan is one in which the plan sponsor purchases
health coverage from a state-licensed insurer. The carrier assumes the risk of providing health
benefits to the sponsor’s enrolled members. In contrast, organizations who self insure (or self
fund) do not purchase health coverage from state-licensed insurers. Self-insured plans refer to
health coverage that is provided directly by the organization seeking coverage for its members
(e.g., a firm providing health benefits to its employees). Such organizations directly take on the
risk for covering medical expenses, and such benefit plans are not subject to state insurance
regulations. Firms that self fund typically contract with third-party administrators (TPAs) to
handle administrative duties such as member services, premium collection, and utilization review.
TPAs do not underwrite insurance risk.
Another common distinction made in health insurance is whether the policy covers one person or
a family. Under self-only coverage, the holder of the insurance policy is the only person insured.
(Self-only coverage is also called individual coverage. Individual coverage in this sense should
not be confused with health coverage from the individual insurance market—see discussion ⁴
above.) Family coverage applies to the policyholder, her/his spouse, and children. Self-only and
family policies may differ from each other in terms of the services they cover and the cost-sharing
they impose.

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Costs for administrative functions encompass a wide range of operational activities.
Administrative expenses include costs associated with contracting with providers, sales and
marketing, enrollment and billing, customer service, utilization review, case management, and
other functions. Because of economies of scale, administrative expenses in the group market are a ⁵
smaller portion of overall costs, compared to those in the nongroup market.
Unlike most industrialized countries, the United States does not guarantee health coverage to all
of its citizens. Instead, it relies on a patchwork approach that combines private and public means
for providing health insurance and health care. One of the key pieces of this approach encouraged
the growth of employment-based health coverage via the tax code.
Section 106 of the Internal Revenue Code states that employer contributions to employment-
based health insurance are not included in workers’ gross incomes for tax purposes. This tax
preference encourages workers to sign up for (“take-up”) health coverage within the work setting.
A separate ruling by the Internal Revenue Service clarified that such employer contributions are
business expenses and, therefore, deductible from employers’ taxable income. Both parties
benefit: employers use health insurance coverage as a means to recruit and retain workers, while
workers typically get access to more services at better rates (see discussion below). However,
workers generally receive reduced wages to compensate for richer benefits.
The tax exclusion of health benefits is one of the primary reasons why health insurance coverage
is provided mainly through the workplace in the United States. Approximately two out of three
nonelderly (under 65) Americans have employer-sponsored insurance. Moreover, of nonelderly
persons with private health coverage, approximately nine out of 10 obtain it through the ⁶
workplace.
Health insurance regulation addresses a wide variety of issues: the benefits that must be offered,
the individuals to whom the insurance is made available, and the responsibilities insurers have to
plan enrollees, to name a few. One of the most contentious issues regarding health insurance
regulation is whether it is the responsibility of individual states or the federal government. This
distinction is important because federal and state laws governing health plans differ on issues
such as patient compensation in courts, consumer access to care, and mandated coverage for
certain benefits.

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The regulation of insurance traditionally has been a state responsibility, as clarified by the 1945
McCarran-Ferguson Act. However, overlapping federal requirements complicate the matter with
respect to health insurance. Individual states have established standards and regulations
overseeing the “business of insurance,” including requirements related to the finances,
management, and business practices of an insurer. For example, all states have laws that require
state-licensed insurance carriers to offer coverage for specified health care services (known as
“mandated benefits”). Because fully insured plans are subject to state-established requirements,
those plans must offer those mandated benefits. On the other hand, self-insured plans are not
subject to state insurance regulations so they are exempt from such requirements.
Regardless of whether health plans are fully-insured or self-funded, they all are subject to a
number of federal laws. Two of these federal laws, the Employee Retirement Income Security Act
of 1974 (ERISA, P.L. 93-406) and the Health Insurance Portability and Accountability Act of

1996 (HIPAA, P.L. 104-191), have significant impact on how health insurance is provided.

ERISA outlines minimum federal standards for private-sector employer-sponsored benefits.
(Public employee benefits and plans sponsored by churches are exempt from ERISA). Passed in
response to abuses in the private pension system, the act was developed with a focus on pensions
but the law applies to a long list of “welfare benefits” including health insurance. The act requires
that funds be handled prudently and in the best interest of beneficiaries, participants be informed
of their rights, and there be adequate disclosure of a plan’s financial activities. ERISA preempts
state laws that “relate to” employee benefit plans. (In other words, the federal law overrides state
laws affecting private-sector employee benefits). This portion of ERISA was designed to ensure
that plans would be subject to the same benefit laws across all states, partly in consideration of
firms that operate in multiple states. However, state laws still apply for issues which involve the
“business of insurance.” The delineation of issues attributable to the phrases “relate to” and
“business of insurance” is not clear, and have led to longstanding debates and active litigation ⁷
over the scope of ERISA preemption.
The core motivation behind the Health Insurance Portability and Accountability Act of 1996
(HIPAA) is to address the concern that insured persons have about losing their coverage if they
switch jobs or change health plans (“portability” of health coverage). The act’s health insurance
provisions established federal requirements on private and public employer-sponsored health
plans and insurers. It ensures the availability and renewability of coverage for certain employees
and other persons under specified circumstances. HIPAA limits the amount of time that coverage
for pre-existing medical conditions can be excluded, and prohibits discrimination on the basis of
health status-related factors. The act also includes tax provisions designed to encourage the
expansion of health coverage through several mechanisms, such as authorizing tax-advantaged
medical savings accounts and a graduated increase of the portion of premiums self-employed
persons may deduct from their federal income tax calculations. Another set of HIPAA provisions
addresses the electronic transmission of health information and the privacy of personally

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identifiable medical information (administrative simplification and privacy provisions, ⁸
respectively).
The most current, publicly available data on employer health benefits found that the average
annual premium for self-only coverage was $4,479 in 2007. The average premium for a family of ⁹
four was $12,106. Together, these premiums represent a 6.1% increase in the cost for employer-
sponsored health benefits compared to last year’s average premiums. While this signals a reprieve ¹⁰
from double-digit increases in recent years, the premium growth rate nonetheless outpaces both
wage gains and the growth in prices for all goods and services. For 2007, the average growth rate
for health insurance premiums was twice as much as the growth rate for overall inflation (2.6%), ¹¹
and one and a half times as much as the growth rate for workers’ earnings (3.7%).

While health insurance coverage is not necessary to obtain health care, it is a useful mechanism
for accessing services in an environment of increasingly expensive health care. As health care
costs continue to rise, more people need greater assistance with covering medical expenses.
Health insurance provides some measure of protection for consumers, especially those who have
limited means or greater-than-average need for medical care.
Health insurance is considered important also because of the well-documented, far-reaching
consequences of uninsurance. For instance, uninsured persons are more likely to forgo needed
health care than people with health coverage. This includes forgoing services for preventable or ¹²
chronic conditions which often leads to worse health outcomes. Uninsured persons also are less
likely to have a “usual source of care,” that is, a person or place identified as the source to which
the patient usually goes for health services or medical advice (not including emergency rooms).
Having a usual source is important because people who establish ongoing relationships with
health care providers or facilities are more likely to access preventive health services and have ¹³
regular visits with a physician, compared with individuals without a usual source. Therefore, to
the extent that health insurance coverage facilitates access to basic medical services, people
without coverage face substantial barriers in the pursuit of the health care they need. For 2003-04,

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^exa^m^p^l^e,^{see M}^e^rc^{er p}^r^{ess rel}^ease^oⁿ^lⁱⁿ^e,^“U.^S^.^em^p^l^o^y^er^{s’ h}^eal^t^h^b^eⁿ^e^fⁱ^t^co^st^coⁿ^tⁱⁿ^u^e^{s t}^o^ri^{se at}^t^wⁱ^c^{e i}ⁿ^f^l^atⁱ^oⁿ^rat^e^,
^Me^rc^e^r^surv^e^y^fⁱ^nds,”^Nov^e^m^b^e^r^19,²⁰⁰⁷^{, a}^t^http^://w^ww^.^m^e^r^c^e^r.c^o^m^/^re^f^e^re^nc^e^c^onteⁿ^t.j^h^tm^l?^idCon^t^eⁿ^t=¹²⁸⁷⁷⁹^0.
¹¹^Em^ploy^e^r^H^e^alt^h^Be^ne^fi^ts^S^u^r^v^e^y^{, p.}^19.
¹²^Kai^s^{er Co}^mmⁱ^ssi^oⁿ^on^M^e^di^cai^{d an}^d^t^h^{e Un}ⁱⁿ^su^red,^“T^h^e^Unⁱⁿ^sur^e^d^an^d^T^h^ei^{r A}^{ccess t}^o^Heal^t^h^Care,^”^No^ve^m^b^er
²⁰⁰^{5 a}^t^htt^p^://w^ww^.^k^ff^.org^/uni^nsure^d^/^l^oa^de^r.c^f^m^?^ur^l=^/^c^om^m^onspo^t/se^c^u^rity^/^g^e^t^f^ile^.c^fm^&^P^a^g^e^I^D=²⁹²⁸^4.
¹³^J.^E^.^DeVo^e,^et^al^.^,^“Recei^p^t^o^f^P^r^even^tⁱ^v^{e Care}^Am^oⁿ^g^A^d^u^l^t^s^:^In^s^u^ran^{ce S}^t^at^u^s^and^Usu^a^l^S^o^u^r^{ce of}^Care,^”
^Am^e^r^ic^{an J}^our^nal^of^Pu^blic^H^e^alt^h^{, Ma}^y²⁰⁰^3.

almost 10% of nonelderly adults with private health insurance identified no usual source of care, ¹⁴
compared with around 49% of uninsured, nonelderly adults who reported no usual source.
The negative consequences of uninsurance extends beyond the persons directly involved. The
Institute of Medicine found that the insurance status of parents affects the amount of health care ¹⁵
their children receive. In locations with crowded emergency rooms, rising uninsurance rates can
exacerbate that problem, since uninsured persons have fewer places from which they can get
medical services compared to people with health coverage. Overcrowding in emergency
departments, in turn, leads to longer waits for all patients seeking emergency care. Moreover,
many uninsured persons forgo preventive health care and end up developing more serious
conditions requiring complex, expensive medical services. Since health coverage is positively
related to income, uninsured persons are less likely to be able to afford this level of care. In cases
where patients are unable to cover the costs associated with receiving health services, the
facilities that provided those services must take it as a financial loss (i.e., uncompensated care).
These losses can be staggering. For example, one study estimated that health care providers ¹⁶
would provide nearly $41 billion worth of uncompensated care to the uninsured in 2004.
Ultimately, though, the costs for caring for the uninsured are “passed down to all taxpayers and
consumers of health care in the form of higher taxes and higher prices for services and ¹⁷
insurance.” Taxpayers are affected because the federal government makes payments to
hospitals, which take into account the share of poor people treated. The assumption is that
facilities that treat a larger proportion of poor people have a greater problem with uninsurance and
uncompensated care. The federal government also provides grants to many health centers and
other facilities that serve poor communities. In addition, states and localities fund local health
programs, public hospitals, and clinics—facilities that generally serve an uninsured or medically
underserved population. Health care consumers are affected by uninsurance because in order for
physician practices and hospitals to survive financially they have to make-up the losses they
sustain. Hospitals and physicians may raise rates for certain services or discontinue unprofitable
programs in order to recoup those losses, thereby affecting consumers’ pocketbooks and access to
services. Uninsurance, then, has negative health and financial consequences for uninsured
persons, their families, communities, and the nation as a whole.

Americans obtain health insurance in different settings and through a variety of methods (see
Table 1). People may get it through the private sector, or from a publicly funded social insurance
program. Consumers may purchase health coverage on their own, as part of an employee group,
or through a trade or professional association. A small minority of employees get health insurance
at no up-front cost because their employer pays the total premium. However, approximately 47

¹⁴^Na^tiona^{l Ce}ⁿ^t^e^r^f^o^{r He}^a^{lth Sta}^tis^tic^s,^H^e^alth,^Uⁿ^ite^{d St}^ate^s^,²⁰⁰⁶^,^T^a^ble^{77, a}^t^http^://w^ww^.^c^dc^.g^ov^/ⁿ^c^h^s/^da^ta^/hus/
^hus⁰⁶^.^pdf^#e^x^e^c^u^tiv^e^s^u^m^m^a^r^y^.
¹⁵^Instit^ute^of^Me^dicⁱ^ne^,^Com^m^itte^e^on^the^C^onse^q^ue^nc^e^s^of^Uninsur^a^nc^e^,^C^o^v^e^r^age^M^a^tte^r^s^:^Iⁿ^s^u^r^aⁿ^c^e^{and H}^e^a^lth
^Ca^re^{, 20}⁰¹^.
¹⁶^J^.^H^a^dle^y^a^{nd J}^.^H^o^la^haⁿ^,^“^T^he^C^o^s^t^of^C^a^r^e^f^o^r^the^Uⁿⁱⁿ^s^u^r^e^d:^W^h^a^t^D^o^W^e^Spe^nd,^W^ho^P^a^y^s^{, a}^{nd W}^h^a^t^W^oul^d
^{Full C}^o^v^e^r^a^g^e^A^{dd to}^Me^dic^a^l^Sp^e^nding^?^,^”^Issu^{e Upd}^a^t^e^,²⁰⁰⁴^{, a}^t^http:^//w^w^w^.kf^f^.or^g^/unins^ur^e^d^/⁷⁰⁸^4.c^f^m^.
¹⁷^Instit^ute^of^Me^dicⁱ^ne^,^Com^m^itte^e^on^the^C^onse^q^ue^nc^e^s^of^Uninsur^a^nc^e^,^{A S}^har^e^d^D^e^s^tiny^{, 20}⁰³^,^p¹²²^.

million Americans did not have health insurance coverage for the entire year of 2006; that is, ¹⁸
nearly 16% of the total population were uninsured.
Table 1. Health Insurance Coverage for All Persons, by Type of Insurance, 2006
^Population
^{(millions) Coverage}^Distribution
^{Total P}^opulation^296.⁸^100.^0%
^{Employment Based}^177.²^59.7%
^Nongroup^27.1^9.1%
^{Medicare 40.3}^13.6%
^{Medicaid/SCHIP/State Programs}^38.3^12.9%
^{Military/Veterans Coverage}^10.5^3.6%
^{No Health I}^nsu^rance^47.0^15.8%
^Source:^{U.S. Census Bu}^{reau, Cu}^{rrent Pop}^{ulation Survey, 2}⁰⁰⁷^An^{nual Social and Economic Supple}^{ment, Table}
^HI0^{5, at http://p}^ubd^b3.cen^sus.gov^/macro/03²⁰^07/^health/^h05_0^00.h^tm.
^Notes:^Co^{lumns do not add to totals because}^persons^{may rec}^{eive insura}^{nce coverage}^{from more}^{than one}
^{source. The most c}^urre^nt^{national data on health insu}^rance^cover^{age for an e}^{ntire year}^{is for 2}⁰⁰^6.
Even though examples of health insurance in this country stretch back more than 200 years, most ^th¹⁹
Americans did not have health coverage until the latter half of the 20 century. The demand for
more workers during World War II and a wage freeze imposed by the National War Labor Board
generated great interest in employer-sponsored insurance (ESI) as a worker recruitment and ²⁰
retention tool. Buoyed by legislation and court rulings declaring the tax exemption of fringe
benefits, and support from unions for work-based coverage, health insurance became a pervasive
employment benefit.
In employer-sponsored insurance, risk pools may be comprised of active workers, dependents,
and retirees. Insurers use a number of strategies to increase the likelihood that each risk pool
includes a good proportion of healthy individuals, thus avoiding adverse selection. For instance,
insurers may restrict employees’ opportunities to take-up health coverage or switch health plans
by designating a specific time frame each year for such activities (“open enrollment period”).
This strategy decreases the likelihood that people will “game” the system by taking up coverage
only when they plan on using health services (e.g., for pregnancy and birth), and dropping
coverage when they no longer plan to access care. Insurers also may require the employer to
enroll a certain proportion of the firm’s eligible population. Assuming that the eligible population
consists of a good percentage of healthy people, requiring a certain proportion of all eligibles to
enroll leads to an enrollee population which contains at least some healthy people. Employers

¹⁸^U^.^{S. C}^e^ns^us^B^u^r^e^a^u^,^Iⁿ^c^o^m^e^,^Po^v^e^r^ty^{, and H}^e^a^{lth I}ⁿ^s^u^r^anc^e^C^o^v^e^r^ageⁱⁿ^the^Uⁿ^ite^d^St^ate^s^:²⁰⁰⁶^{, A}^u^g^u^s^t²⁰⁰^{7, p.}
^{18 a}^t^htt^p^://w^w^w^.ceⁿ^s^u^s^.^g^o^v^/^prod^/20⁰⁷^p^u^b^s^/^p60-²³^3.p^d^f^.
¹⁹^Se^e^tim^e^line^f^r^o^m^E^m^ploy^e^e^Beⁿ^e^f^{it Re}^se^a^r^c^h^Institute^{’s “}^H^istory^of^He^a^{lth Insura}^nc^e^Be^ne^f^its,”^Ma^rc^{h 20}^02,^a^t
^http:^//www^.e^bri.org^/^pu^blic^a^tio^ns/^f^a^c^ts/ja^m^e^s/^dis_0³⁰²^f^a^c^t^.c^fm^.
²⁰^Heal^t^h^In^su^raⁿ^{ce A}^sso^ci^atⁱ^oⁿ^o^f^Ameri^ca,^Fundam^eⁿ^tals^{of H}^e^al^t^h^Iⁿ^s^u^r^anc^e^{, 19}⁹⁷^.

also use strategies to encourage insurance take-up by healthy people. For example, employers
usually pay part (or, in very few instances, all) of the total premium. This practice makes health
coverage a more attractive benefit, even to those who do not plan to use medical services on a
regular basis.
ESI plans retain enrollees better than the individual health insurance market. As previously
mentioned, health benefits provided at the workplace are exempt from income and employment
taxes, encouraging the growth and continuity of employer-sponsored health insurance. Large risk
pools with a good proportion of healthy enrollees tend to be more stable than small pools or those
with a higher proportion of unhealthy enrollees. Given the strategies discussed above to
discourage adverse selection, insurers assume that ESI pools—particularly large, diverse ones—
are relatively stable. Generally, this translates into less volatile costs and better premiums overall
in the group market compared to the nongroup market. Also, large ESI groups can use their size
to negotiate for better benefits and lower cost-sharing, in contrast to individual applicants in the
nongroup market. Plan sponsors negotiate and interact with insurers on behalf of all of their
insured members, unlike in the individual market where each consumer must deal with the
insurance carrier directly in order to apply for and purchase coverage. In addition, there are
economies of scale for enrollees in the group market compared to the nongroup market for
administrative functions such as sales, billing, and customer service. For these reasons, workers
and their families benefit from receiving coverage through the workplace. For plan sponsors, the
main advantage is to use health benefits for recruitment and retention of workers. This is
particularly appealing in a growing economy—such as during most of the 1990s—when there
may be high demand for workers.
While there are many advantages to obtaining ESI coverage, there are challenges as well. From
the vantage point of the enrollee, one of the biggest disadvantages is the general lack of
portability. Because ESI coverage is tied to the job and not the person, any change in employment
(such as going from full-time to part-time status, or changing jobs) may alter the health care
providers or services to which the worker has access, or disrupt health coverage altogether. Also,
in firms that offer health coverage, there is a trade off made between wages and benefits. For
workers who do not take up health insurance from those firms, they end up accepting lower
wages for a set of benefits they do not use. From the perspective of the sponsor, an underlying
challenge is the lack of enrollee awareness of the true costs of health care. Because the sponsor
contributes to the cost of the premium, enrollees do not bear the full cost of obtaining health
coverage. Also, enrollees generally do not have to cover the entire cost of the services they use,
since sponsors negotiate for lower rates and better cost-sharing arrangements from insurers.
Consumers enrolled in managed care plans particularly are shielded from health care’s true costs.
Some observers contend that this lack of cost awareness gives little incentive to consumers to
utilize medical services prudently, which leads to greater use of services and greater overall
health care expenditures. In addition, sponsors’ efforts to constrain their health care spending—by
increasing the employee share of the premium or cost-sharing—are made even more difficult to
justify or implement. Finally, from the perspective of the federal budget, the tax exclusion of
employer-sponsored health insurance represents a lost source for Treasury funds. (The Joint

Committee on Taxation estimated the FY2007 income tax exclusion for employer-paid insurance ²¹
to be almost $100 billion.)
The group insurance market often is thought of as consisting of large and small groups. The
underlying reason for this distinction is rooted in the inverse relationship between insurance risk
and group size (i.e., the risk associated with a group grows as the size of the group shrinks). This
concept affects employers’ offers of health benefits. For instance, a very large employer often is
able to offer multiple health plan options to its members (e.g., the Federal Employee Health
Benefit Program (FEHBP)). A large business can leverage its size to get a more comprehensive
set of benefits. In contrast, small employers are less able to provide health coverage at all because
of the greater risk associated with small groups. Even when small employers do offer coverage,
the benefits are often limited. Small employers also are much less likely to self-fund health
coverage, since there is a smaller pool for spreading risk and protecting against catastrophic loss.
Furthermore, such firms generally do not have the necessary administrative capacity to negotiate
with multiple provider groups and handle all the day-to-day operational functions. It is conditions
such as these which prompt legislators to develop proposals for expanding small group
participation in health insurance; for example, by establishing association health plans, and
opening up FEHBP to the small group market.
Association health plans are just one example among the spectrum of entities which bring groups
of people together for the purpose of buying health insurance. These entities include trade and
professional associations that offer health coverage to their members (“association-sponsored
plans”), and small firms that band together to purchase coverage as a group (“health insurance
purchasing cooperatives”). The premise behind group purchasing arrangements is to decrease the
administrative burden on and increase the negotiating capacity of participants who cannot afford
to offer or purchase coverage on their own. Around one-third of small firms buy health coverage ²²
through some type of purchasing pool.
While most Americans with health insurance obtain it through the private-sector, tens of millions
of people get their health care covered through public programs. Below are descriptions of
selected federal and state programs which provide payments on behalf of many persons who, due
to low incomes or high health care expenses, could not afford health care otherwise.
The Medicare program was established in 1965, and is a federal program for persons age 65 and
older and certain persons with disabilities. Medicare consists of four parts: Part A, Hospital
Insurance; Part B, Supplementary Medical Insurance; Part C, Medicare Advantage (replaced the
Medicare+Choice program with the passage of the Medicare, Prescription Drug, and

²¹^For^a^dditi^ona^l^inf^o^r^m^a^{tion o}ⁿ^t^h^e^ta^x^tr^e^a^t^m^e^{nt of}^he^a^{lth be}^ne^f^its^{, s}^e^e^C^R^S^R^e^por^{t R}^L³³⁵⁰^5,^Tax^Be^ne^{fits for He}^alth
^Iⁿ^s^u^r^a^nc^e^an^{d Ex}^pe^ns^e^s^:^O^v^e^r^vⁱ^ew^{of C}^u^r^r^e^{nt L}^a^w^aⁿ^d^Le^gis^l^ati^oⁿ^{, by}^B^{ob L}^y^k^e^a^{nd J}^u^lie^{M. W}^h^it^t^a^k^e^r^.
²²^For^a^dditi^ona^l^inf^o^r^m^a^{tion, s}^e^e^C^R^S^R^e^por^t^R^L³¹⁹⁶³^,^As^s^o^cⁱ^a^tioⁿ^Spo^ns^or^e^d^H^e^alth^Pl^ans^:^Le^gis^l^at^ion^{in t}^h^e¹⁰⁹^th
^C^ongr^e^s^s^,^b^y^Jean^Hearn^e^.

Modernization Act of 2003 (MMA, P.L. 108-173); and Part D, the prescription drug benefit also
added by MMA. The Medicare program provides coverage for a wide range of medical services,
such as care provided in hospitals and skilled nursing facilities, hospice care, home health care,
physician services, physical and occupational therapy, outpatient prescription drug benefits, and
other services. Since its creation in the mid-1960s, Medicare has provided health coverage to tens
of millions of American. In 2005, the program had approximately 40 million enrollees. Medicare
has been so successful in covering the elderly that the problem of uninsurance usually is ²³
described in terms of the under-65 population.
Medicaid is the main health insurance program for low-income Americans. It is a means-tested
program, and applicants must meet financial and other criteria in order to be eligible for program
services. Everyone who meets the eligibility criteria is entitled to Medicaid benefits available in
their state of residence. Medicaid provides coverage for health care and long-term-care services to
certain adults (generally parents and pregnant women), children, the elderly, and persons with
disabilities. It is jointly funded by federal and state governments, and is administered by the states
within federally set guidelines. State Medicaid programs provide a comprehensive set of services,
reflecting its diverse enrollee population. These programs must provide a set of federally
specified benefits, such as hospital services (both inpatient and outpatient), physician services,
nursing home care for ages 21 and over, home health care for those entitled to services from
nursing facilities, and certain services for children. States may also cover additional optional
services. Some states have used waiver authority under Medicaid to extend coverage to uninsured
persons who do not meet the program’s categorical (e.g., childless adult with no disability) and/or ²⁴
financial tests.
The State Children’s Health Insurance Program was established in 1997 to allow states to cover
uninsured low-income children who are ineligible for Medicaid. In designing their programs,
states can choose among three options: expand Medicaid, create a new “separate state” insurance
program, or devise a combination of both approaches. States that choose to expand Medicaid to
SCHIP eligibles must provide the full range of mandatory Medicaid benefits, as well as all
optional services specified in their state Medicaid plans. States that establish SCHIP programs
that are separate from Medicaid choose one of three benefit options. All 50 states, the District of
Columbia, and five territories have established some type of SCHIP program. SCHIP’s eligibility
rules target uninsured children under 19 years of age whose families’ incomes are above
Medicaid eligibility levels. States may raise the upper income level for low-income children up to ²⁵

200% of the federal poverty level, or higher under certain circumstances.

The individual insurance (“nongroup”) market is often referred to as a “residual” market. The
reason is because this market provides coverage to persons who cannot obtain health insurance

²³^For^a^dditi^ona^l^inf^o^r^m^a^{tion a}^b^o^u^t^Me^dic^a^r^e^,^s^e^e^C^R^S^R^e^por^{t R}^L³³⁷¹²^,^M^e^dic^a^re^{: A Prime}^r^,^by^Je^nnif^e^{r O’Sulliv}^aⁿ^.
²⁴^For^a^dditi^ona^l^inf^o^r^m^a^{tion a}^b^o^u^t^Me^dic^aⁱ^{d, s}^e^e^C^R^S^R^e^p^o^r^t^R^L³³²⁰²^,^M^e^dic^aⁱ^d^{: A}^Prime^r^{, by}^Elic^ia^J^.^H^e^rz^.
²⁵^For^a^dditi^ona^l^inf^o^r^m^a^{tion a}^b^o^u^t^SC^H^I^{P, s}^e^e^C^R^S^R^e^p^o^r^t^R^L³⁰⁴⁷^3,^S^t^ate^C^h^il^dr^eⁿ^’^s^H^e^alt^h^Iⁿ^s^u^r^a^nc^e^Pr^ogr^am
⁽^S^CHIP^{): A}^B^rⁱ^e^f^Overvi^ew^{, by}^E^lic^ia^J^.^H^e^rz^{, Chris}^L^.^P^e^te^rs^on^{, a}^{nd Ev}^e^l^yⁿ^e^P^.^Ba^um^ruc^k^e^r^.

through the workplace and do not qualify for public programs such as Medicare, Medicaid, or
SCHIP. Consequently, the enrollee population for this private health insurance market is small.
The residual nature of the nongroup market is evident in the demographic make-up of those who
purchase coverage from it. The market is over-represented by the near elderly (55-64 years old); a
group that has relatively weak attachments to the workplace. The individual market
disproportionately consists of part-time workers, part-year workers, and the self-employed, ²⁶
groups unlikely to have access to ESI coverage. Also, some people use the nongroup market as
a temporary source of coverage, such as those in-between jobs or early retirees who are not yet
eligible for Medicare.
Applicants to the individual insurance market must go through robust underwriting. Insurance
carriers in most states conduct an exhaustive analysis of each applicant’s insurability. An
applicant usually must provide her/his medical history, and often undergo a physical exam. This
information is used by carriers to assess the potential medical claims for each person. Federal and
state requirements restrict somewhat insurers’ ability to reject applications or design coverage
based on health factors (such as benefit exclusions for certain pre-existing health conditions).
Nonetheless, some applicants are rejected from the nongroup market altogether, and others who
are approved may receive limited benefits or are charged premiums that are higher than those in ²⁷
the group market for similar coverage. Rigorous underwriting results in an enrollee population
that is fairly healthy (three out of four enrollees report that their health is excellent or very ²⁸
good), thereby excluding persons with moderate to severe health problems from the private
nongroup insurance market.
A majority of states have established high risk health insurance pools. These programs target
individuals who cannot obtain or afford health insurance in the private market, primarily because
of pre-existing health conditions. If such individuals are not eligible for public programs (e.g.,
their incomes may exceed the financial eligibility requirements), they have very few options for
obtaining coverage. In general, high risk pools tend to be small and enroll a small percentage of
the uninsured. As of the first half of 2006, 34 states had high risk pools with participation of ²⁹
nearly 193,000 enrollees. While health benefits vary across states and plans, they generally
reflect coverage that is available in the private insurance market, with required cost-sharing for
enrollees. The majority of high risk pools cap premiums between 125% to 200% of market rates,
and pools often are subsidized through assessments imposed on insurance companies, general ³⁰
revenue, or other funding mechanisms.

²⁶^D^.^J^.^C^h^olle^t,^“^C^ons^um^e^r^s^,^Iⁿ^s^u^r^e^r^s^{, a}^{nd Ma}^r^k^e^t^B^e^ha^vⁱ^or^,”^J^o^urn^a^{l o}^f^He^alt^h^P^o^litic^{s, P}^o^lic^y^aⁿ^d^Law^{, Fe}^br^ua^r^y
²⁰⁰^0.
²⁷^M.^V.^P^a^uly^a^{nd A}^.^M.^P^e^r^c^y^,^“^C^os^{t a}ⁿ^d^P^e^r^f^or^m^a^nc^e^:^A^C^o^m^p^a^r^ison^of^the^Iⁿ^divⁱ^dua^l^aⁿ^d^G^r^{oup H}^e^a^{lth I}ⁿ^s^u^r^a^nc^e
^M^a^rket^s,^”^J^our^nal^{of H}^e^al^th^Poli^tⁱ^c^s^{, Polic}^y^aⁿ^d^Law^{, Fe}^br^ua^r^y^2000.
²⁸^G^e^ne^ra^l^A^c^c^ountiⁿ^g^O^f^fⁱ^c^e^,^“^P^ri^v^a^te^H^e^a^{lth Ins}^u^ra^nc^e^:^Milli^ons^R^e^l^y^ing^{on I}^ndivⁱ^d^u^a^l^Ma^rk^e^t^F^{ace Co}^st^an^d
^C^o^v^e^r^a^g^e^T^r^a^d^e^-^Of^f^s^,”^N^ovem^b^er¹⁹⁹⁶^.
²⁹^Sta^t^e^s^w^{ith hig}^h^ris^k^p^o^o^l^s^:^A^L^,^A^K^,^A^R^{, C}^A^{, CO}^{, CT}^{, FL}^{, ID}^{, IL, IN}^{, IA}^{, K}^S^{, K}^Y^,^L^A^{, MD}^{, MN}^,^{MS, MO}^,^MT^,
^N^E^{, N}^H^,^N^M^{, N}^D^,^O^K^,^O^R^{, SC,}^SD^{, T}^N^{, T}^X^{, U}^T^{, WA}^{, W}^I^{, W}^V^a^{nd W}^Y^.
³⁰^For^a^dditi^ona^l^inf^o^r^m^a^{tion a}^b^o^u^t^s^t^a^t^e^hig^h^rⁱ^s^k^po^ols^,^s^e^e^C^R^S^R^e^por^{t R}^L³¹⁷^45,^H^e^alth^Iⁿ^s^u^r^anc^e^:^Sta^t^e^Hⁱ^g^h^Ris^k
^Pools^,^b^y^Bern^ad^et^t^e^F^e^rn^an^d^ez.

Despite the multiple private and public sources of health insurance, millions of Americans are
without health coverage. In 2006, nearly 47 million people were without health insurance
coverage for the entire year. For the vast majority of the uninsured, they lack coverage because
they cannot access coverage (e.g., their employer does not offer health insurance as an
employment benefit) or they cannot afford it.
Uninsurance is characterized as a problem of the under-65 population, given near-universal
coverage of seniors through Medicare. The nonelderly uninsured population differs from the
insured population on a number of key demographic factors. One of the most striking
characteristics of persons who lack coverage is that a significant proportion are in low-income
families. For instance, among all uninsured persons under age 65, more than half were in poor or ³¹
near poor families in 2006. Moreover, among nonelderly persons who are poor, 34% lacked
health coverage. This proportion is almost triple the share of nonelderly individuals with
moderate/high incomes who had no health insurance (12%).
A defining characteristic of the nonelderly uninsured population is that 82% are persons with ties
to the paid labor force, or dependents of such persons. Even more surprising is that 57% of the
nonelderly uninsured were workers with full-time, full-year status, or the dependents of those
workers. While such findings may be counter-intuitive, there are multiple reasons why employed
persons and their families may lack health coverage. For example, a worker may be offered health
insurance by his/her employer, but declines it because he/she thinks it is too expensive. An
employee may work for a small firm which is less likely than a large firm to offer health
insurance as a benefit. A low-wage employee, even working full time, is less likely to be offered
health insurance at work and less likely to be able to afford it than higher-wage workers in the
same firm. Finally, a healthy worker may be willing to take on the risk of being uninsured and
choose not to purchase insurance at all. So despite the dominance of employer-sponsored health
insurance, the dynamics of work, insurance risk, and financial resources intersect to impede the
coverage of all workers and their families.
The problem of the uninsured is an ongoing concern to many policymakers and legislators. One
of the topics of ongoing debate is the overall number of uninsured individuals and the direction of
the uninsurance rate. These issues have generated some controversy over dueling analyses which ³²
show slightly different (and sometimes, moderately different) findings. But despite the forceful
discussions regarding trends in uninsurance, the year-to-year changes in the uninsurance rate
actually are small. For example, from 1987 to 2006, the change in the uninsurance rate from year ³³
to year has been less than 1%. Nonetheless, tens of millions of Americans were without
coverage during that time period. Such circumstances beg the questions: why does pervasive
uninsurance persist (even during the robust economy of the mid-1990s), and what are the
implications for legislation and public policies to expand health coverage?

³¹^T^h^e^pov^e^r^ty^lev^e^{l f}^o^r^a^f^a^mⁱ^l^y^o^f^f^our^w^a^s^aⁿ^a^nnua^{l inc}^o^m^e^of^$20,61^{4 (}^w^eⁱ^g^h^te^{d a}^v^e^r^ag^e⁾^{in 20}⁰⁶^;^s^e^e
^http:^//w^w^w^.c^eⁿ^s^u^s^.^g^o^v^/^hhe^s^/^w^w^w^/^pov^e^r^ty^/^t^hr^e^s^hld^/^thr^e^s^h06.^htm^l^.
³²^For^a^dis^c^us^sⁱ^oⁿ^of^the^v^a^rⁱ^o^u^s^s^o^ur^c^e^s^of^da^ta^on^he^a^{lth i}ⁿ^s^u^r^a^nc^e^c^o^v^e^r^a^ge^{, s}^e^e^C^R^S^R^e^por^{t R}^L³¹²^75,^He^alth
^Iⁿ^s^u^r^a^nc^e^:^Fe^de^r^a^{l D}^a^ta^So^ur^c^e^s^for^A^naly^s^e^s^of^the^Uⁿ^ins^u^r^e^d^{, b}^y^Ch^{ris L}^.^P^e^tersoⁿ^an^d^Ch^ristin^e^{M. Dev}^e^re.
³³^{Data av}^ailab^l^{e at h}^ttp^://w^ww^.cen^su^s.g^o^v^/^h^h^e^s/^www/^h^l^t^hⁱⁿ^s/^hⁱ^sto^rⁱ^c^/h^ih^istt¹^.^h^t^m^l^.

Given the complexity of the health care system overall, it is no surprise that health benefits are
delivered and financed through different arrangements. Those arrangements vary due to
numerous factors such as: how health care is financed, how much access to providers and services
are controlled, and how much authority the enrollee has to design her/his health plan. While
delivery systems may share certain characteristics, general distinctions can be made based on
payment, access, and other critical variables.
Under indemnity insurance, the insured person decides when and from whom to seek health
services. If the services the enrollee receives are covered under his/her insurance, the enrollee or
the enrollee’s provider files a claim with the insurer. Thus, insurers make payments
retrospectively (i.e., after the health services have been rendered), up to the maximum amounts
specified for each covered service. In this model of health care delivery, the financing of health
services and the obtaining of those services are kept separate.
This bifurcated arrangement was unquestioned for a time. But as medical costs began to rise,
sometimes faster than other sectors of the national economy, many observers criticized this
delivery model as contributing to increasing expenses. Because providers were compensated on a
fee-for-service basis, some argued that providers were not given incentives to provide efficient
health care. In fact, some critics accused health care practitioners and institutions of providing an
over-abundance of health care in order to generate greater revenue. By the early 1970s,
legislators, analysts, and others expressed considerable interest in alternative models, such as
managed care models, with cost control as a key feature.
While managed care means different things to different people, several key characteristics set it
apart from traditional (indemnity) insurance. One of the main differences is that the service
delivery and financing functions are integrated under managed care. Managed care organizations
(MCOs) employ various techniques to control costs and manage health service use prospectively.
Among those techniques are restricting enrollee access to certain providers (“in-network”
providers); requiring primary-care-physician approval for access to specialty care
(“gatekeeping”); coordinating care for persons with certain conditions (“disease management” or
“case management”); and requiring prior authorization for routine hospital inpatient care (“pre-
certification”). MCOs may offer different types of health plans that vary in the degree to which
cost and medical decision-making is controlled. As a consequence, enrollee cost-sharing also
varies. Generally, the more tightly managed a plan is, the less the premium charged. Other
distinguishing features of the managed care approach include an emphasis on preventive health
care and implementation of quality assurance processes.
Managed care was touted as the antidote to rapidly rising health care costs. Starting with the
passage of federal legislation in the 1970s which supported the growth of managed care
(specifically in the form of health maintenance organizations (HMOs)), the number of MCOs

grew quickly. Increased market competition among these organizations led to decreases in
premiums, in order to gain market share. With high medical inflation in the 1980s and early
1990s, enrollees flocked to these less-costly managed care plans. By the mid-1990s, more insured
workers were enrolled in HMOs than any other health plan type, and health insurance premiums
had stabilized.
But in the latter half of the 1990s, a “backlash” of sorts against managed care grew.³⁴ Some
enrollees had grown weary of provider and service restrictions. Many MCOs that had increased
market share through artificially-low premiums began to raise them in order to increase ³⁵
revenue. Consumers and others accused the managed care industry of caring more about
controlling costs than providing health care. Some providers resented the role managed care
played in medical decision-making. Many enrollees began to leave HMOs. The industry
responded by developing insurance products that were less-tightly managed, but more costly.
Some traditional HMOs widened their provider networks and eliminated the gatekeeping
function, while employers began to offer plan types that were less tightly managed, such as
preferred provider organizations (PPOs). In fact, by the end of the 1990s, more people with work-³⁶
based health coverage were enrolled in PPOs than in HMOs.
As the influence of managed care waned and health care costs began to rise at an increasing pace
during the late 1990s, the impact on consumers began to be felt. For example, in the employment
setting, employers absorbed the extra costs at first in order to recruit and retain workers during ³⁷
the booming economy of the mid to late 1990s. But as the economy soured, employers began to ³⁸
pass these expenses along to enrollees in the form of greater cost-sharing.
By the end of the 1990s, large increases in health costs again became commonplace. With the
belief by some observers that the age of managed care was over, they began to search for
alternatives. Consumer driven (or consumer-directed) health care have been offered as one such
option.
Consumer driven health care refers to a broad spectrum of approaches that give incentives to
consumers to control their use of health services and/or ration their own health benefits. In the
workplace, at one extreme employers may choose to provide an array of insurance products from
which workers can choose, while at the other end an employer could increase wages but not offer
any health coverage allowing workers to decide how to spend that extra money to meet their

³⁴^Ric^h^a^r^{d Kro}ⁿ^ic^k^,^“^W^a^iting^f^o^{r Godo}^{t: W}ⁱ^she^s^a^{nd W}^o^rrie^sⁱⁿ^Maⁿ^a^g^e^{d Ca}^re^,”^J^ournal^{of He}^alt^h^P^o^litic^{s, Po}^lic^y^an^d
^Law^{, v}^o^l^.²⁴^,^no^{. 5}⁽^O^c^t^obe^r¹⁹⁹⁹⁾^,^p^p^.¹⁰^99-¹¹^06.
³⁵^Joⁿ^G^a^b^e^l^,^et^al^.^,^“Job^-Based^Heal^t^h^In^s^u^ran^{ce i}ⁿ²⁰⁰¹^{: Inf}^l^a^tioⁿ^{Hits Dou}^b^le^Dig^{its, Ma}^na^g^e^{d Ca}^r^e^Re^tre^a^t^s,”
^He^{alth Af}^fairs^{, v}^o^l^.^20,ⁿ^o^.^{5 (}^S^e^p^te^m^b^e^r^/Oc^t^obe^r²⁰⁰¹⁾^,^pp.¹^80-¹^86.
³⁶^Ameri^can^Asso^ci^atⁱ^oⁿ^o^f^Heal^t^h^P^l^aⁿ^s,^“Heal^t^h^P^l^aⁿ^{s an}^{d E}^m^p^l^o^y^er-S^p^oⁿ^s^o^r^ed^P^l^an^s,^{” Oct}^o^b^e^{r 199}⁹^.^A^v^ai^l^a^b^l^{e at}
^http:^//w^w^w^.a^hip.or^g^/^c^onteⁿ^t/^de^f^a^ult.a^s^px^?^b^c⁼^41|^331|^366.
³⁷^J^{on B}^.^C^h^rⁱ^s^t^ia^ns^oⁿ^aⁿ^{d Sa}^lly^T^r^ude^{, “}^M^aⁿ^a^g^ing^C^o^s^t^s^,^Ma^na^gⁱ^ng^B^e^ne^f^its^{: Em}^plo^y^e^r^D^e^cⁱ^sⁱ^onsⁱⁿ^L^o^c^a^l^H^e^a^lth
^{Care Mark}^ets,”^H^e^{alth Se}^r^v^ic^e^s^Re^s^e^ar^c^h^{, pt. I}^I^{, v}^o^l.³⁸^,^no.^1,⁽^F^e^b^r^u^a^r^y²⁰⁰³⁾^,^p^p^.³⁵^7-³⁷³^.
³⁸^J^{on G}^a^be^{l, e}^t^a^l^{., “}^J^o^b^-^B^a^s^e^d^H^e^a^{lth B}^e^ne^f^its^{in 2}⁰⁰²^:^Som^e^I^m^por^ta^{nt T}^r^e^nds^,”^H^e^a^l^th^A^f^faⁱ^r^s^{, v}^o^l^.^21,ⁿ^o^.⁵
⁽^S^e^p^te^m^b^e^r^/O^c^t^obe^r²⁰⁰²⁾^,^p^p^.¹^43-¹⁵^1.

health care needs. Within those two endpoints, the consumer directed approach varies in the ³⁹
degree to which consumers are responsible for health care decision-making.
For example, one health benefits option that is at the heart of discussions about consumer driven
care is the health savings account (HSA). Under this approach, the consumer is responsible for
management of the account. HSAs are investment accounts in which contributions earn interest
tax free. Consumers, their employers, or both may make contributions to HSAs. Consumers
withdraw funds on a tax-free basis to cover medical expenses not covered by health insurance.
Unused contributions roll over to the next year. HSAs must be paired with high-deductible health
plans. If the HSA funds are exhausted and the deductible level has not been reached, the
consumer is responsible for covering that gap. Once the consumer’s spending reaches the
deductible level, then coverage from the high-deductible plan takes effect. HSAs received a
legislative boost when they were authorized in November 2003 by the Medicare Prescription ⁴⁰
Drug, Improvement, and Modernization Act of 2003 (P.L. 108-173).
While consumer driven health care can take on many forms, the premise common to all of the
approaches is that by making enrollees more responsible for their own health care, it creates
incentives for people to use services prudently. The expectation is that greater cost-consciousness
on the part of consumers will result in lower overall health costs. In essence, the service and cost
control functions administered by MCOs and providers under managed care shifts to enrollees
under the consumer driven health care scenario.
Proponents of consumer directed plans assert the merit in having people take increased
responsibility for their own health care use and expenses. They predict that this approach will
lead to better-informed consumers, more appropriate use of health services, and lower overall
spending on health care. Opponents express concern that this approach does not recognize the
possible range of health conditions in an enrolled population. They argue that these plans benefit
the young and healthy who use relatively few services, and, therefore, would not need to expend a
great deal of time and energy making these health care decisions. However, these plans impose a
greater burden on individuals with moderate to severe health conditions because of their greater-
than-average use of medical services.

^B^e^rn^{adette Fern}^an^dez
^Aⁿ^a^l^ystⁱⁿ^H^e^a^l^t^h^Ca^r^e^Fi^na^ncⁱ^ng
^bf^ern^aⁿ^d^ez^@^c^rs^.l^oc.g^o^v^{, 7-}⁰³²²

³⁹^P^.^Fr^onsti^{n, e}^d^.,^Em^ploy^e^e^Be^ne^{fit Re}^se^a^r^c^h^Institute^,^C^o^ns^um^e^r^-^D^rⁱ^v^eⁿ^H^e^{alth Be}^ne^fi^ts^:^{A C}^ontiⁿ^uin^g^Ev^ol^uti^oⁿ^?
²⁰⁰^2.
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^by^B^{ob Ly}^ke^.