Unique American Health Insurance Policies Cause Price Inflation

Abstract:     
Many studies conclude that the main reason Americans pay more for health care is that its providers charge higher prices. There is little agreement on why prices are higher. I argue that higher prices are caused by a type of insurance contract unique to America. “Service benefit” contracts originated by Blue Cross/Blue Shield plans paid no monetary “indemnity” to the people insured. Rather payments went directly to providers. Initially participating providers accepted the plan benefit as payment in full, and, so long as this remained true, these contracts provided no special incentive for providers to raise their prices. This changed around 1950, when independent insurance companies began to market a new type of policy called “major medical”. These policies were imitated by the Blues and, in so doing, they introduced “coinsurance” and “deductibles” provisions into the service benefit plans. In these new service benefit hybrids, providers were free to charge patients more than the plan benefit to be paid directly by the patient. An unintended consequence of this development was the release of an inflationary spiral. A model, based on the theory of two-sided matching, provides quantitative predictions of the increase in provider prices caused by insurance. The model can quantitatively account for the inflationary spiral observed from 1949 to 1959. If service benefit insurance is the major cause of the rise in provider prices, then a reform proposed here could reverse the spiral.

Number of Pages in PDF File: 29

Keywords: healthcare costs, health insurance, health provider prices

JEL Classification: H51, I11, I13

working papers series