In 1965, Medicare and Medicaid were added to the Social Security Act (SSA) to provide the basis for assuring significant numbers of elderly and poor coverage for healthcare. (Titles XVIII and XIX, Social Security Act, As Amended; 42 U.S.C. §§ 1395, et seq. and 1396, et seq.) Prior to that time, although "home relief," federal pensions and state aid were available, meager resources were available for healthcare. Also, there was no national uniformity of allocation by the states and the commercial insurance industry concluded that such actuarial groups were impossible risks. Actuarial analysis is the application of probability and statistical methods to calculate, from prevalence and incidence data, the possible occurrence of events such as illness, hospitalization, disability, or death for a given population. A common use of actuarial analysis is the calculation of risk-insurance premiums, and for the insurer, or government insurance regulator, the necessary reserves. Under managed care, actuarial analysis although helpful to a company’s start-up years, is not as essential as it is to indemnity insurers.

Competition between managed-care companies is significantly affected by the fact that they can control their losses up to a point by initial denial of care and withholding payment for services delivered. Indemnity insurers must estimate their risk more closely since they are state regulated and forbidden to manage it, and cannot compete with each other by withholding payments for losses. Since both programs were remedial legislation, the definition for reimbursement by the government for services rendered was:

This statute was amended significantly during the Nixon Administration, in 1972, and defined the reasonable costs of services (formerly considered as those which were necessary in the efficient delivery of needed services) as follows:

Under Medicare, funds were directly paid to providers on behalf of beneficiaries from the Medicare Trust. (42 U.S.C. § 1395j). For the poor, funds for medical assistance, on the basis of a "Federal medical assistance percentage," (42 U.S.C. §§ 1396b, 1396d(b) were provided the states with a State Plan that had to be approved by the Secretary of the Department of Health and Human Services. (Then called "Department of Health, Education and Welfare.")  (42 U.S.C. §§ 1396, 1396a.)

In August 1971, President Nixon ordered a 90-day freeze on prices, wages, salaries and rents, and the creation of a Cost of Living Council to administer the freeze and to advise on further economic stabilization policies. Three months later, phase II of the Economic Stabilization Program (ESP) began. The ESP goal was to reduce the rate of inflation to about one-half of the pre-freeze rate. In December 1971, specific mandatory phase II rules were promulgated for the healthcare industry, rules which were continued for that industry when phase III, the voluntary control program, began in January 1973. Modified controls were imposed on the healthcare industry in June of 1973 ("Phase IV"). These price controls ended in April 1974 soon after President Ford took office.

On an annualized basis, all consumer prices, less medical care, had risen by 9.3 percent for the post-control period ending in September 1975, while medical care prices rose 12.6 percent. (National Health Insurance Resource Book. Rev. Ed., Aug. 30, 1976. Prepared by the Staff of the Committee on Ways and Means, U.S. House of Representatives, for the use of the Committee, at 90-91). This greater rate of medical-care price increases post-Phase IV reflected in part the extra years of mandatory controls faced by the healthcare industry, compared with the "voluntary" nature of price controls for most of the rest of the economy, since capital projects were limited under mandatory, but not voluntary, controls.

In 1972 Congress extended Medicare and Medicaid coverage for the last time and enacted a section for "utilization review." One newly covered group consisted of disabled workers under age 65, who were made eligible for disability benefits as well as Medicare for their medical needs. (Pub. L, 92-603, Title II, § 201(a)(2), (3) substituted "aged and disabled individuals" for "individuals 65 years of age or over." 42 U.S.C. §§ 1395c and 1395j. The other group was made up of "aged, blind and disabled" poor who would now receive "Supplemental Security Income" provided in part with federal funds through state plans. (Pub. L. 92-603, § 301; Title XVI, Social Security Act; 42 U.S.C. § 1381a and §§ 1382 through 1382c.) Also added was medical assistance for poor children under 21 suffering from "nervous or mental disease." This extended coverage for such children to be treated in "psychiatric hospitals" when a state plan so provided. (Pub. L. 92-603, § 299B(b); 42 U.S.C. § 1396d(h)(1976)). Coverage for "nervous and mental diseases" were from the beginning not on par with coverage for other illnesses. Under Medicare, lifetime limits for mental hospitalization were established at 190 days, except if they were treated in general hospitals, and Medicaid covered only such illnesses occurring in persons over the age of 65.

But by far the most significant aspect of the 1972 amendments was that it marked the end of much of the social remediation of healthcare as envisioned by the Johnsonian "Great Society"—and started the government on a path of micro-management of the Social Security Act that continued to run interference for the healthcare insurance industry to this day. In 1972 the original intent of extending access to healthcare was simultaneously pared thin through take-back amendments that had the effect of converting the Medicare trusts into a fungible feeding trough to be used for other governmental purposes, while setting in place a paradigm for future mimicry by private insurance interests. This was accomplished through the new utilization review sections and the cost-reporting sections of the 1972 law. The first allowed the Secretary to "utilize the procedures [used by states under Medicaid] if such procedures were determined to be superior in their effectiveness . . . ," (42 U.S.C.A. § 1395x(k), n. at 811 (1992)) and encouraged the Secretary to contract with "utilization and quality control peer review organizations . . . in order to promote the effective, efficient, and economical delivery of health care services of proper quality for which payment may be made . . . . (Sections 1320c-1 through c-19)12, 13; and 42 U.S.C. § 1320c).

This section and the ones which followed it, the "Professional Standards Review Organizations" (PSROs), were repealed and replaced by sections of the "Tax Equity and Fiscal Responsibility Act of 1982" (TEFRA), which established the present "Prospective Payment System" (PPS). (Pub. L. 97-248, § 143.)  The PSROs, after 10 years of operation, were apparently unable to satisfy the "efficiency" and "economical" requirements of their takeback expectations since they ended their legislated existence with a net loss of $125 million. They were replaced by "Peer Review Organizations" (PROs) which have been able to perform somewhat more efficiently in prospective and retrospective denials of reimbursement to hospitals and practitioners for patient care; (42 U.S.C.A. §§ 1320c through 1320c-19 (1992); but their cost-cutting "efficiency" pales in comparison with the care denials by managed care as we know it today.

Congress also changed the "reasonable cost" section referred to above, adding a provision defining such costs. "The reasonable cost of any services shall be determined in accordance with regulations establishing the methods to be used, and the items to be included, in determining such costs for various types or classes of institutions, agencies, and services," was changed to,

Yet what remained in the original section was a clause that has been the subject of much litigation over the years as the courts have attempted to fashion some meaningful interpretation of the virtually incomprehensible assurance that by setting "limits" on costs the Secretary deems "unnecessary" in the "efficient delivery" of healthcare, neither other government programs nor the private sector arrangements would have to bear the costs of the Medicare program and vice versa:

Despite much subsequent judicial review of challenges to this obvious cost-shifting to the private sector (numerous citations omitted), the die was now cast for healthcare costs to rise proportionately for the non-governmental indemnity insurance programs as well as for those that continued to pay privately. As the losses to doctors and hospitals were passed through to the private sector, the prices of individual and group premiums began to soar from the mid-1970s through the late 1980s, giving rise to the fiction that doctors and hospitals were the beneficiaries of such prices. This was later used to promote the theme that the new pension law, the 1974 Employee Retirement Income Security Act (ERISA), could come to the rescue since it had state-regulation-free "managed care" potential.

As can be seen from a table in The National Health Insurance Resource Book referred to above (at p. 243), "Total Income" data for commercial insurers were not made available to the congressional research staff; only "Premium Income" was revealed. This enabled a comparison between the then nonprofit "Blues" Plans and the for-profit commercials to appear as if both groups suffered similar loss ratios, when in fact the commercial companies made significant profits from their insurance components as their consolidated financial statements showed.

The term "loss leader" was applied by the industry to the group healthcare portion of the insurance portfolio to appear as if group insurance was only sold to "get other business," similar to the use of advertisements that offer low -priced items as a technique to get buyers into a department store or supermarket. Note the inability of the commercial insurers to conceal the profitability of "Individual policies" because of the unconscionably low "Claims expense as a Percent of premium income." Thus, quite the opposite is true for insurance. Because insurance premiums are paid in advance (except in rare cases when sickness occurs during a "grace period"), their use in investments affords great monetary advantage. Selling insurance is a cash flow-to-investment portfolio business in that it depends more on its revenue from sales than on its profits from the premiums. In manufacturing, only profits are important since their investment is a consequence of, and secondary to, earning them.

In many states, indemnity insurance with a claims expense below 65 percent is not allowed to be sold as "insurance" at all since the risk to the insurer is so low, such premium prices would amount to a sham. The insurers’ claim that selling individual policies is an even greater loss leader than losses sustained from group policies because of the greater cost to administer. This is reflected in the "Operating expense" column. That claim is highly suspect since people do not get sick in groups. Some states require individual policies to be one of the insurance products sold. The insurers assert that the expense of operating and selling individual policies is greater than the claims expenses and that the policies are sold for "good-of-the-public." Yet the extreme profitability of individual policies is obvious. Indeed, it is so great because of the small loss ratio--that it does not constitute enough of a risk to be called insurance--a portent of the era of "managed-care-managing-risk."

The 1972 legislative "giving with one hand and taking with the other" also set in place a congressional and administrative ethos of "cost containment" as public health policy and provided an example which the private insurance industry eagerly adopted and exaggerated for years. In short, in order to provide for the "general welfare," Congress recognized in 1965 that the actuarially sicker elderly and poor needed remedial legislation. The insurance industry, however, saw that such public policy considerations could also be arrogated as the predicate for private-sector reversal of the gains made by working people since the Roosevelt years.

Please send your comments on the above:  Rye Hospital Center - Rye, New York, as you await the next installments:

Phase Two: Broadening the Actuarial Base of Healthcare

       •   1. The HMO Act

       •   2. ERISA and Federal Preemption