Table of Contents
History of the healthcare system in America 1
Healthcare in the 19th century 1
Founding of the American Medical Association 2
Early models of insurance 6
Explorations in national healthcare 8
Further government actions in healthcare 9
Rising costs and the specialization of physicians 10
Development of the current insurance provider model 12
Works Cited 16
High costs, frustrations, and low service levels have characterized many people’s experiences with the healthcare industry. When patients see their doctors, they hope to receive answers to their questions and a clear understanding of the options available to them. Instead, they are shuttled from waiting room to examination room and back to the reception desk with a feeling that they have been rushed through or that their questions have only been partially addressed. Much of the healthcare industry is bewildering and frustrating to patients. People are left asking, how did things get to this point and why is it costing so much? This paper attempts to answer that question by providing a historical perspective to the healthcare industry.
Over the past hundred years or so, the nature of the healthcare organization has changed from a peer-to-peer structure where doctors had a relatively intimate relationship with a small body of patients to a hierarchical structure where administrative organizations, such as hospitals and managed care groups, act as a filter between patients and doctors. One of the consequences of this shift in organizational structure has been a high degree of information asymmetry that has resulted in rising costs. Furthermore, the flow of information between doctors and patients has become highly distorted. This paper explains how these changes to the system occurred in terms of information flow and organizational responses to an evolving system.
In the early 19th century the system
of American healthcare had developed into a truly free market. Between the 1830s and 1850s, congress
repealed most of the laws governing medical licensing which had been inherited
from the British colonial government
One of the consequences of such a free market
system was a large supply of physicians across the nation. Providing education to these doctors was a
large number of medical schools. With barriers
to entry being very low and medical education cheap and easy to come by, the
number of doctors in the nation was quite large. In fact, the nation had more than 40,000
practicing physicians and population of fewer than 20 million. This amounted to about one doctor for every
500 citizens. Accordingly, competition
was fierce and physicians were paid quite little. Even the most educated of doctors might not
expect to receive more than the “merest pittance in the way of remuneration”
During this period of time, the structure of the nation’s healthcare system was very simple. Doctors treated patients directly, and there were no intervening agents. Physicians did not belong to healthcare provider networks, and patients had no managed care plans. The relationship between patients and doctors was a personal one. Furthermore, the high ratio of physicians to patients meant that each doctor treated fewer patients. One can conclude from this that physicians would have had an intimate relationship with clients as they had few patients to treat and more time to devote any one patient.
Because there were fewer formal organizational
barriers between doctors and patients, the nature of system as a whole would
have been one of many disconnected peer-to-peer type networks centered on the
physicians. There was no formal
structure to link fellow physicians together except in hospitals, and even
there the organizational ties were loose
In 1847 the American Medical Association (AMA) was
founded by a group of physicians from the New York Medical Society and
representatives from 28 other states. The
AMA was founded with the goals of scientific advancement, standards for medical
education, launching a program of medical ethics, and improved public
Later this code would be expanded to govern
over other activities such as: (1) “solicitation of patients, either directly
or indirectly," (2) "competition and underbidding," (3) “compensation
... inadequate to secure good medical service," (4) “interference with
reasonable competition in a community," and (5) “impairment of ‘free
choice’ of physicians." According
to Goodman and Musgrave, the AMA code of ethics was tantamount to endorsing a
medical cartel and making participation by physicians an ethical obligation
The AMA pursued its goals by lobbying both federal and state governments to enact strict medical licensing laws designed to restrict the supply of new physicians entering the market for healthcare services. By 1901, all states and territories with the exceptions of Alaska and Oklahoma had medical examining boards. However, many of these regulatory bodies had divergent standards for the education of physicians. In 1906 the AMA Council on Medication conducted an inspection of the nation’s medical schools and found less than half of them to be acceptable. In 1910, in order to gain legitimacy for its findings, the AMA convinced the Carnegie Foundation for the Advancement of Teaching to conduct the same study. This study, conducted by Abraham Flexner, came to be known as the Flexner Report.
As Reuben Kessel said, “If impact on public
policy is the criterion of importance, the Flexner report must be regarded as
one of the most important reports ever written”
As a consequence of this legislation, many medical
schools that did not pass the new standards for teaching would be shut
down. This had the simultaneous effects
of reducing the supply of physicians and increasing the overall quality of care
provided by the average physician. As
one scientist of the era remarked, “It was about the year 1910 or 1912 when it
became possible to say of the US that a random patient with a random disease
consulting a doctor chosen at random stood better than a 50-50 chance of benefiting
from the encounter”
When examining the impact of the AMA on the
healthcare system from an information flow standpoint, the AMA acted as a mass
filter on the new information entering the system. Desouza and Hensgen define a filter as an
agent or device that removes “unwanted noise from the signal of interest”
As fewer and fewer medical schools were able
to meet the AMA’s criteria for licensure, they lost their accreditation and
were closed. As a consequence, the
capacity to train physicians was diminished. Graduations of physicians fell
each of the subsequent 20 years. This
had a disproportionate effect on minority physicians. African American physicians, once common,
were generally not admitted to AMA licensed schools, and African American
medical schools were systematically closed as they failed achieve AMA licensure
It is during this period of time, that the healthcare system as a whole began to develop its own organizational culture and structure. By gaining the sole regulatory ability to license the nation’s medical schools and set the standard for practicing physicians, the AMA was beginning to impose a degree of order on a previously chaotic system. At this point, the nation’s system of medical education had developed a hierarchy at the macro level were decisions came down from the AMA and impacted the medical schools and physicians under its authority.
This change to the supply of physicians meant
that number of patients being treated by an individual physician would be
greatly increased. This in turn, caused
an increase in the complexity of the system.
As Desouza and Hensgen noted, in order to deal with an increasingly
complex flow of information, organizations have tended to respond by developing
hierarchical systems to manage, filter, and distribute the flow of information throughout
The concept of financially insuring oneself
against the possibility of future expenses is not a new one. Insurance has been around since the days of Babylonian
traders who feared that their shipments across the desert might fall prey to
bandits or other disasters
The development of health insurance in the late
1920s had it beginnings in, “isolated communities where employers provided
insurance to their employees and thereby were able to attract physicians to
take care of their workforce”
The concept of offering ‘hospital insurance’ as
an employment benefit soon began to take hold and employers and hospitals became
the focal point of health services. Initially
employers administered the plan, which had the effect of reducing overhead administrative
costs, and physicians or hospitals were contracted to treat the plan members at
a fixed rate. The result was a health
insurance plan where the contracted physician or hospital would fix as many illnesses
or injuries as necessary without charging extra fees. This was in effect, a prepaid healthcare
plan. With the onset of the Great Depression
in the 1930’s the prepaid solution even became popular with physicians because
it guaranteed them a salary at a time when few people had the financial resources
to see a private physician whose services were generally more expensive
Eventually this system would evolve to
encompass multiple hospitals. The
arrangement changed from one where a group of subscribers contracted with a
particular hospital to a system under which subscribers and contracted
physicians could select any hospital that was a member of the plan. Physicians were contracted with either
individually or as a group. Hospital association-sponsored
not-for-profit-plans, such as the Blue Cross soon began to develop. The not-for-profit Blue Cross associations in
different states accepted the responsibility of serving the entire
community. These plans developed a
community–rating system under which the one fee designed to reflect the average
costs in the community was charged to all members of the plan. Such flat-fee programs made generally equal
healthcare available to all those who could afford the premium regardless of
the resources they consumed
At the same time that the non-profit plans
were reaching maturity, for-profit healthcare plans were beginning to
develop. These plans were primarily
marketed to healthy individuals participating in Blue Cross-type plans who were
attracted to the lower premiums offered by the for-profit plan. Such plans offered lower premiums to low-risk
individuals and excluded high-risk individuals.
In this way they competed effectively with the Blue Cross’s system that
based it’s premiums on average community risk.
As low-risk individuals fled to less expensive plans, “The average risk
for those remaining with the Blues increased and, as a consequence, so did
The introduction of employers and insurance
companies to the system added a new layer of complexity to the system. Furthermore, access to healthcare was
expanding, which also contributed to increased size and complexity. Before these developments, a consumer’s
interactions with the system were mostly limited to physicians and hospitals,
the providers of healthcare. With the
introduction of insurance companies and employer-sponsored health plans, the
number of entities a patient was required to interact with doubled. While this marked a distinct change in the system
from a patient’s point of view, the initial homogeneous nature of the plans
acted to minimize the complexity being added to the system. A consequence of this new model was that it
encouraged indifference in patients towards information related to the costs of
By 1933, the nation as a whole was beginning to
seriously explore the idea of a national healthcare plan. The Committee on the Costs of Medical Care
had conducted an extensive census of national healthcare and determined that
the majority of expenses were concentrated in a small high-risk percentage of
the population. However, since all
citizens run the risk of experiencing a medical crisis, the committee decided
to recommend that all Americans, “…assume some form of collective responsibility
for medical costs”
However, universal health care had many
opponents. Morris Fishbein, editor of
the Journal of American Medical Association (JAMA) and a prodigious writer, was
a vocal opponent of national health insurance.
Fishbein was an advocate of the sanctity of the patient-physician
relationship and believed that a national healthcare plan would violate the
intimacy of that bond. Fishbein also
opposed corporate medicine, prepaid hospital insurance, and even fee-for-service
health insurance. To him all of these
threatened to interject a third party organization between the doctor and the
Fishbein’s concerns were well founded. As previously mentioned, third party organizations such as employer-sponsored insurance and prepaid hospital insurance plans had already interjected another entity into information flow between doctors and patients. At this point in time, those entities were causing minimal disruption to the information being passed between doctors and patients. Perhaps prophetically, Fishbein had predicted that these entities would become major sources of distortion in the communication channel.
Throughout the 1940s and especially during
World War II, the number of insured Americans rose dramatically. This is in large part due to the National Labor
Relations Board’s 1948 ruling that health benefits were subject to collective
bargaining. By 1950 about 54.5 million
Americans, roughly one third of the population, had health insurance
During this same time period the demand for trained
physicians was beginning to eclipse the available supply. President Johnson’s administration proposed to
address this by doubling the enrollment at medical schools through a series of
generously funded federal programs designed to encourage the development of new
medical schools and expand the enrollment of existing schools. The plan also proposed to address the
shortage of physicians in rural areas through economic incentives and to lower
physicians’ fees by increasing supply relative to demand
During this period of history the regulatory actions by the government induced more change in the system than at any time since the Flexner report. Government action had helped cause the rapid rise in the number of insured Americans and the related expansion of the healthcare system as a whole. Furthermore, the creation of the Medicare and Medicaid programs introduced the government as an agent directly involved in the interaction between patients and healthcare providers. With the addition of Medigap and other supplemental insurance providers, patients were now faced with two intermediary agents in their interaction with physicians. By this point, the structure of the healthcare system had become quite complex and the chances for distortion in the information flow between patients and physicians had been dramatically increased by the new developments in health insurance and government intervention.
Contrary to its intent of producing more
general practitioners and lowering costs, the actions of the Johnson
administration dramatically increased the number of specialist physicians and
consequently the associated costs. Due
to the outflow of government spending in the Medicare program, physicians
specializing in eldercare became one of the fastest growing segments of the
healthcare industry. Rather than see a
family doctor, more and more elderly patients began consulting with geriatric
specialists. These physicians offered complex
and often expensive therapies with the promise of prolonged life
The demand for health coverage from employers
also increased. According to Lundberg,
to stay competitive employers were forced to provide healthcare plans offering
immunizations, prenatal care, periodic checkups, and preventative screenings. There was no opposition to this from
physicians or the AMA. Hospital based
doctors began to increase their fees on a regular basis and met little
resistance as most patients’ insurance plans did not require the payment of any
out of pocket fees
Soon the same obscuration of costs affecting
doctor’s fees began to affect the coverage of prescription drugs. Lundberg explains, “Once payments were made
by 3rd party payers, resistance to price increases diminished”
In addition to the obscuration of fees, the payment model for physicians had nearly universally changed from a salary based model to a fee-for-service model. Doctors were now paid for the individual services they provided. This meant that the more patients a doctor treated the more doctor would be paid, and the more expensive the treatment the more the doctor would be paid. Lundberg offers the following explanation.
It is at this stage in the evolution of the system that
information asymmetry becomes a real problem.
Information asymmetry is a situation where one party, the agent, conducts
work for the other party, the principal, yet for some reason, usually self
interest, does not fully disclose all relevant information. In the resulting situation, the principal has
less information pertaining to the topic at hand than the agent
With coverage rates and costs increasing,
insurance providers both private and government based began to enact measures
to control raising costs of comprehensive care.
At some point in the 1970s, insurance providers began a trend of
reducing coverage and limiting benefits in an effort to curb their raising
expenses. Also concerned with continuously
escalating costs of comprehensive care, the federal government enacted a series
of laws designed to contained costs. The
Employee Retirement Income Security Act (ERISA), enacted in 1974, included
provisions to oversee health benefit plans and freed most employers from state
regulations regarding coverage standards.
Lundberg explains that, “Employers offering coverage through
self-insurance often used insurance carriers to administer their plans, using
restrictive networks and methods to constrain coverage”
This trend towards a reduction of benefits
continued to gain momentum into the 1990s.
Journalist and economist Robert Kuttner claimed that throughout the
1990s, “The most prominent feature of American health insurance coverage is its
Overall, the trend throughout this period has
been to place more of the financial burden for healthcare on the consumer. Additionally, the number of underinsured has
been on rise also. The underinsured
represent the portion of the population with some health benefits, but who must
forgo treatment because their healthcare plans will not cover medically
The previously described trends can be explained as a reaction of the system to the changes in its previous state. The reduction in benefits coverage is an organizational response to the rapidly increasing costs and information asymmetry of the previous decades. Employers and insurance companies acted in their own best interests to reduce expenses without dramatically reducing the size of the insured population. The asymmetry of information in relationship between physicians, insurance providers, and their patients also increased. Under the direction of HMOs, some physicians would decline to inform patients of possible treatments not covered by their health plans. In effect, insurance providers and healthcare providers filtered and restricted the flow of available information to patients. With their access to information regarding the choices and consequences of their medical treatment, patients now more than ever before are disconnected from the physicians responsible for their treatment.
The American healthcare system is a very complex organization with many stakeholders ranging from patients and doctors to employers and insurance providers. But in coming to understand the history of the system, it has been possible to examine how changes to the organizational elements of the system and how their interactions have ultimately resulted in the frustrations that patients experience today. While the revolution in medical science and the development of complex insurance systems over the past century has dramatically increased the quality and accessibility of healthcare in United States, the results have proven to be expensive as well.
In the early days of the American healthcare system, the free market nature of the system kept organizational complexity fairly low. Doctors and patients enjoyed a less restricted relationship, and there were no other entities to distort the flow of information between the two. The founding of the AMA and the granting of monopoly power over medical education to the AMA marks the beginnings of a pattern of ever increasing complexity and expense in the system. Furthermore, the AMA’s monopoly over medical education both increased the quality of medical service in the nation and initiated a shift from a free market system to a closed market.
The development of early models of health insurance further increased the organizational complexity of the system. Furthermore, this marked the first time that a third party was interjected into the flow of information between doctors and patients. This marked the beginning of a pattern of information asymmetry that would lead to escalating costs and rising demand. Increasing government intervention in the system further added to the levels of complexity and caused a dramatic increase in both costs and insurance coverage that would further exacerbate the asymmetry in information between doctors, insurers, and patients. This chain reaction of organizational changes and distortion of information has ultimately shaped the healthcare system into what it is today.
Part of the problem in this system is that Americans pretend to embrace a free market system in healthcare, but their actions have created a closed market that encourages the obfuscation of costs. An essential component of a free market system is consumer access to information regarding the costs of services. However, the system of healthcare this nation has been designed to specifically hide the costs of services from consumers and works to short-circuits competition in the market. The nation should embrace one clear direction for the healthcare market. Whether that is a free market system, a heavily regulated market, or a nationalized system, the future of the nation’s healthcare system would benefit from a clear vision.
Future decision makers in the healthcare system would be well advised to consider the implications of their actions on the organizational dynamics and information flows of the healthcare system. All actions taken on specific parts of the system will inevitably have consequences beyond the designer’s intentions. Future actions taken on the healthcare system must take into account the effects they will have on the information flow between physicians and their patients.
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