The Birth of the "Blues"

Four characteristics of Blue Cross/Blue Shield health insurance fundamentally shaped the way Americans paid for health care in the postwar period.

First, hospitals were reimbursed on a cost-plus basis. If Blue Cross patients accounted for 40 percent of a hospital's total patient days, Blue Cross was expected to pay for 40 percent of the hospital's total costs. If Medicare patients accounted for one-third of patient days, Medicare paid one-third of the total costs. Other insurers reimbursed hospitals in much the same way. For the most part, physicians and hospital managers were free to incur costs as they saw fit. The role of insurers was to pay the bills, with few questions asked.

Second, the philosophy of the Blues was that health insurance should cover all medical costs—even routine checkups and diagnostic procedures. The early Blue plans had no deductibles and no copayments; insurers paid the total bill and patients and physicians made choices with little interference from insurers. Therefore, health insurance was not really "insurance." Instead, it was prepayment for the consumption of medical care.

Third, the Blues priced their policies based on what is called "community rating." In the early days this meant that everyone in a given geographical area was charged the same price for health insurance regardless of age, sex, occupation, or any other factor related to differences in real health risks. Even though a sixty-year-old can be expected to incur four times the health care costs of a twenty-five-year-old, for example, both paid the same premium. In this way higher-risk people were under-charged and lower-risk people were over-charged.

Fourth, instead of pricing their policies to generate reserves that would pay bills that weren't presented until future years (as life insurers and property and casualty insurers do), the Blues adopted a pay-as-you-go approach to insurance. This meant that each year's premium income paid that year's health care costs. If a policyholder developed an illness that required treatment over several years, in each successive year insurers had to collect additional premiums from all policyholders to pay those additional costs.