By offering a solution to the problem of high medical bills, the Baylor Plan contributed to the evolution of a unique financing scheme that preserved a medical care system based on technically advanced nonprofit hospitals.

The plan for prepaid hospital care established in 1929 at Baylor University Hospital played a key role in the evolution of the Blue Cross Association and of voluntary health insurance in the United States. The Baylor Plan itself was a response to the financial problems resulting from the changing role of the nonprofit hospital. [kw]Baylor Plan Introduces Prepaid Hospital Care (1929)
[kw]Prepaid Hospital Care, Baylor Plan Introduces (1929)
[kw]Hospital Care, Baylor Plan Introduces Prepaid (1929)
Insurance industry;development
Health insurance
Baylor Plan
Blue Cross Association
Insurance;health
[g]United States;1929: Baylor Plan Introduces Prepaid Hospital Care[07130]
[c]Health and medicine;1929: Baylor Plan Introduces Prepaid Hospital Care[07130]
[c]Organizations and institutions;1929: Baylor Plan Introduces Prepaid Hospital Care[07130]
[c]Economics;1929: Baylor Plan Introduces Prepaid Hospital Care[07130]
Kimball, Justin Ford
Rorem, Clarence Rufus
Steenwyk, E. A. van

For much of the nineteenth century, hospitals played the role of shelters for the sick poor. Charitable donations paid the bills. Late in the century, however, the forces that were to change that role began gathering strength. The development of anesthesia in the 1840’s and the triumph of the germ theory of disease in the 1870’s made surgery safer and laid the groundwork for medical laboratories. Medical technology became capital-intensive, nursing became a respected profession, and workers inched into the middle class. Hospital administrators started applying the principles of scientific management Scientific management to the operation of hospitals. By 1920, hospital administrators no longer saw themselves as guardians of the sick poor; rather, they viewed themselves as managers of social capital placed in the community to protect the health of all members. To pay for the operating costs of this social capital, administrators depended less on charity and more on charges. This created problems both for families unable to pay hospital bills and for hospitals unable to collect.

Insurance companies seemed unable to solve this problem by selling policies against medical expenses. Insurance theorists considered medical expenses to be uninsurable because there was no way to set premiums. The mathematics of probability can set premiums for events beyond the control of the insured such as hurricanes, fires, and even loss of income resulting from illness. Medical expenses, however, lie somewhat within the control of the insured, who can buy a larger quantity of, or more costly, services than they would choose if they had no insurance. Insurance creates a “moral hazard” in that those who have it lose the incentive to control their expenditures. Because of this “moral hazard,” insurance companies held back from issuing medical insurance.

Hospital administrators and local entrepreneurs devised their own schemes. Many failed, but a few succeeded. One that succeeded, the plan created by Baylor University in Dallas, Texas—known as the Baylor Plan—is considered to be the forerunner of the Blue Cross prepayment plans.

In 1929, Justin Ford Kimball, Baylor University’s executive vice president, examined the accounts of the university hospital and noticed that teachers owed many of the bad debts. Kimball divided total hospital expenses by the number of teachers in Dallas to generate an average monthly cost of fifteen cents. He concluded that the hospital could remain solvent and the teachers could remain financially secure if the hospital offered twenty-one days of free care to anyone making a regular monthly payment of fifty cents. More than one thousand teachers enrolled in the plan.

The evolution from the Baylor Plan to a national association of regional plans started with discussions of Kimball’s plan at the 1931 and 1932 meetings of the American Hospital Association. Hospital administrators were eager for new ideas. The Great Depression had cut hospital revenues by 75 percent, and investigations by the Committee on the Cost of Medical Care Committee on the Cost of Medical Care (a privately funded task force) had heightened interest in broader issues. This committee had started a massive investigation of the American medical care system in 1927. Its final report, issued in 1933, advocated voluntary health insurance as a solution to the problem of financing health care for Americans.

The Baylor Plan offered a successful example of such insurance, but it restricted its benefits to a single hospital, limiting the free choice of physician. In 1932 and 1933, hospitals in Sacramento, California; Essex County, New Jersey; and St. Paul, Minnesota, organized prepayment plans that would provide free care in any community hospital that patients and their physicians might choose. The executive secretary of the St. Paul plan, E. A. van Steenwyk, embellished his letterhead stationery with a blue cross, and people began referring to “St. Paul Blue Cross.”

By the end of 1935, fifteen hospital prepayment plans were operating, and they were facing their first challenges. State insurance laws imposed capital reserve requirements on traditional insurance companies because they paid cash indemnities. The managers of the prepayment plans believed that because they offered service benefits, their true reserves rested in the capacities of the hospitals. They believed, therefore, that they did not need to maintain cash reserves. When challenged by insurance commissioners in New York and Ohio, the plans successfully lobbied legislatures for laws that would exempt them from the capital reserve requirements. Such challenges highlighted the need for national coordination of responses to common challenges.

The driving force behind such coordination was Clarence Rufus Rorem, a research associate with the Committee on the Cost of Medical Care. The Julius Rosenwald Fund had financed Rorem’s position. In 1936, the fund’s directors decided to end their support for the Committee on the Cost of Medical Care but granted Rorem $100,000 per year for the next four years to use in any way he chose. Rorem chose to organize a national association of prepayment plans. He persuaded the leaders of the American Hospital Association to sponsor the Hospital Service Association. Hospital Service Association Rorem was the executive secretary.

In 1938, the Hospital Service Association promulgated seven characteristics required for certification of a regional prepayment plan: There could be no stockholders or investments or profits for any individual; the board of directors should have representatives from hospitals, physicians, and the public; state insurance departments should supervise the plans; plans should hold low cash reserves, because their true reserves lay in the capacities of the hospitals; plans should provide service benefits, not cash indemnities; plans should not compete with one another; and all employees would be salaried, with no one working on commission. In 1941, the grant from the Julius Rosenwald Fund ended. The Hospital Service Association became the Council on Hospital Service Plans Council on Hospital Service Plans of the American Hospital Association, supported by dues from the member plans. Rorem remained secretary.

Two events during World War II influenced the evolution of Blue Cross. A War Labor Board decision allowed employers to increase fringe benefits at the rate of 5 percent per year, and the Emergency Maternity and Infant Care Program provided maternity and child-care benefits to the families of military personnel. The War Labor Board decision enabled employers to compete for scarce workers by offering benefits such as group health insurance. Many large employers had plants in the jurisdictions of different prepayment plans. These employers wanted single-package plans including hospital and physician services and applicable to all of their plants.

In 1937, a group of California physicians had organized a nonprofit indemnity insurance plan. Similar plans, under the control of local medical societies, grew into the Blue Shield organizations. Links between the organizations did not arise immediately, but the pressure for such links started from this demand for a single comprehensive package.

The Maternity and Infant Care Program operated through private providers. Its government administrators developed a reimbursement system based on the concept of “reasonable cost.” Previously, plans had reimbursed hospitals on a rough per diem basis. “Reasonable cost” committed them to pay more to hospitals that provided more services.

At the end of 1946, Rorem resigned. The Blue Cross Council officially replaced the Hospital Service Council. In 1960, the Blue Cross Association would replace the Blue Cross Council, but the essential characteristics of Blue Cross were in place by 1946. It was a national organization of nonprofit, noncompeting, regional prepayment plans, offering service benefits to consumers and reimbursing hospitals on the basis of reasonable cost.

Blue Cross saved the nonprofit hospital system from bankruptcy during the Great Depression and pioneered medical care insurance. It contributed to the development of the unique health care system in the United States, which brought flexibility and technical sophistication as well as high costs and limited access.

Noting the success of the prepayment plans, traditional insurance companies began offering group health insurance on a wide basis in 1934. During World War II, health insurance of all types grew rapidly. Between 1947 and 1949, decisions by the National Labor Relations Board and the U.S. Supreme Court established health insurance as a legitimate subject for collective bargaining. Unions and employers extended health insurance until most of the middle class was covered.

The Hospital Reconstruction Act of 1946 Hospital Reconstruction Act (1946) made it illegal for hospitals to refuse care to people unable to pay. This made free care available to the poor. Hospitals could shift the cost of free care by raising charges to the Blue Cross plans and the insurance companies. Cost shifting was consistent with the nonprofit belief that a hospital is a community resource, but it was not consistent with the free market philosophy of the insurance companies. In the clash of philosophies, the Blue Cross system began to unravel. The Blue Cross plans set their premiums through a system called “community rating,” charging all community members the same premium. Traditional insurance companies set their premiums through “experience rating,” charging higher premiums to people using more services and lower premiums to people using fewer. As insurance theorists viewed it, community rating was unfair because it forced low-risk people to subsidize high-risk people.

A plan using community rating cannot compete with one using experience rating. Experience raters can lure a low-risk group away from a community rater by offering rebates to employers or by offering favorable rates to low-risk groups. The community raters, forced to spread the costs of a riskier remnant over a smaller population, must raise their premiums. This gives the experience raters an opening to break off a new group less risky than the average. The process continues until the community raters serve only the high-risk, high-cost part of the market. Competition forced most Blue Cross plans to abandon community rating. Blue Cross plans in some northeastern states continued to use community rating, but with subsidies from state governments.

With experience rating the rule, however, premiums rose beyond the reach of many high-risk groups, particularly the elderly. The inability of the elderly to buy insurance at affordable rates prompted the creation of Medicare, Medicare a system of government insurance for the elderly and for people with end-stage kidney disease.

Following the precedent of the 1960 Federal Employees Benefit Bill, Medicare and Medicaid allowed hospitals to choose to deal either directly with the government or through an intermediary. Most hospitals preferred to deal through Blue Cross, again expanding the role of the national Blue Cross Association.

Shortly after the passage of Medicare and Medicaid, public attention became focused on the increasing cost of health care. In 1933, the United States spent only 4 percent of its gross national product (GNP) on health care, and the Committee on the Cost of Medical Care argued that it should spend more. Beginning in 1950, that percentage began an inexorable march upward, and by the 1980’s health spending had surpassed 10 percent of GNP. Many people argued that the nation should spend less.

Blue Cross and the traditional insurance companies shared the blame for rising costs. Complete coverage for hospital care, some argued, created an incentive for people to use costly hospital care when it was not really needed. Reimbursement for all reasonable costs destroyed some incentives for efficiency and cost control. Moral hazard—the tendency for insured people to seek more costly care—was mentioned again.

The emphasis on cost control strengthened alternative forms of organization. Some large companies chose to self-insure, bypassing all intermediaries. The Social Security amendments of 1972 actively encouraged the formation of health maintenance organizations. Health maintenance organizations began expanding their coverage at the expense both of traditional insurance companies and of the Blue Cross system. The Blue Cross Association remained the major administrative intermediary of the Medicare program. It sponsored major initiatives in health care research and remained a major proponent of the position that the nonprofit hospital is a form of social capital. Insurance industry;development
Health insurance
Baylor Plan
Blue Cross Association
Insurance;health

• Anderson, Odin W. Blue Cross Since 1929: Accountability and the Public Trust. Cambridge, Mass.: Ballinger, 1975. A historical treatment of the origins of the Blue Cross Association based both on interviews with the founders and on the author’s wide experience as a social scientist and researcher. This work is, in part, a response to the highly critical treatment by Sylvia Law, cited below.
• Cunningham, Robert, III, and Robert M. Cunningham, Jr. The Blues: A History of the Blue Cross and Blue Shield System. DeKalb: Northern Illinois University Press, 1997. First complete history of the oldest health insurance companies in the United States sheds light on the development of the American system of health care. Includes glossary and index.
• Law, Sylvia. Blue Cross: What Went Wrong? New Haven, Conn.: Yale University Press, 1974. Well-researched and highly critical analysis of the role of the Blue Cross Association in the U.S. health care field. Includes a brief history of Blue Cross through the period when it became a major intermediary for the Medicare and Medicaid programs.
• MacIntyre, Duncan. Voluntary Health Insurance and Rate Making. Ithaca, N.Y.: Cornell University Press, 1962. A very readable introduction to insurance theory and to the differences between the Blue Cross Association and traditional stock and mutual insurance companies. Includes evenhanded treatment of the experience rating versus community rating controversies.
• Reagan, Michael D. The Accidental System: Health Care Policy in America. Boulder, Colo.: Westview Press, 1999. Examines how American health care policy has been formed over the years. Chapter 2 offers brief discussion of the origins of Blue Cross. Includes index.
• Rorem, C. Rufus. A Quest for Certainty: Essays on Health Care Economics, 1930-1970. Ann Arbor, Mich.: Health Administration Press, 1982. Collection of articles by one of the major architects of the Blue Cross Association includes Rorem’s influential 1933 article on hospital prepayment plans, a key excerpt from the report of the American Hospital Association outlining the characteristics of an acceptable plan, and a number of other articles that clarify the philosophy that grounded the actions of founders of the Blue Cross Association.
• Starr, Paul. The Social Transformation of American Medicine. New York: Basic Books, 1982. An influential interpretive history of medical care in the United States. Focuses in particular on the methods by which the American Medical Association maintained professional control over medical care decision making until late in the twentieth century, when control shifted to professional managers and financial analysts. Places the evolution of Blue Cross and of stock and mutual health insurance within this context.

U.S. Public Health Service Is Established

Roosevelt Signs the Social Security Act

Ford Foundation Is Established