The rise of the HMO

By Douglas S. Wood
CNN Interactive

ATLANTA (CNN) -- The modern-day health maintenance organization (HMO) has its roots in not-for-profit health care organizations like Kaiser Permanente, which was one of the first to offer prepaid group health plans, for construction workers beginning in the late 1930s.

However, few Americans had access to prepaid group health care plans in the 1940s and 1950s. The medical community resisted prepaid health plans, preferring the existing fee-for-service arrangement. Health care plans like Kaiser also faced a host of legal restrictions from state governments.

That all began to change in the early 1970s. Medical costs were rising faster than the economy, which was stifled by rising inflation, and fee-for-service plans were seen as part of the problem.

Under cost-based reimbursement, doctors had little incentive to control costs and hospitals could either raise prices or offer more services to maintain their revenues.

To control costs, the Nixon administration proposed and Congress passed the Health Maintenance Organization Assistance Act in 1973, which created the term HMO and required businesses with more than 25 employees to offer HMO coverage to their employees if they offered any insurance at all. The act also provided federal funds to HMOs during their start-up periods to encourage their development, and created a certification process for organizations to qualify for those federal funds.

The term health maintenance organization was created by Dr. Paul Ellwood, an adviser to President Nixon, and was used to describe any organization that combined insurance and health care in a single organization.

HMOs are protected from most medical malpractice lawsuits under a subsequent federal law that regulates employee benefit plans offered by private employers and unions. That law, the Employee Retirement Income Security Act (ERISA), was enacted in 1974.

Congress passed ERISA to provide federal protection for employee retirement benefits due to concerns over the nation’s private pension system. Included in the law were group health insurance and other employee benefit plans under the law's protection.

ERISA was originally intended to give companies a single federal standard instead of a patchwork of state employee benefit laws. But Congress included a provision in the law that effectively blocks states from directly regulating employer health and other benefit plans.

By the end of the 1970s, managed care was still a small part of the U.S. health care system, with only 5 percent of Americans enrolled in prepaid arrangements. The pace of enrollment began to speed up in the 1980s as health care costs began to increase rapidly and employers saw HMOs as a way to manage those costs. Enrollment increased 400 percent in a decade, from nine million in 1980 to 36 million in 1990. In 1987, 27 percent of employees were enrolled in employer-sponsored managed care plans. By 1996, that number nearly tripled, to 74 percent.

The majority of Americans with health insurance are enrolled in for-profit HMOs, like Aetna or Cigna. For-profit HMOs represent 75 percent of HMO plans, up from 18 percent in 1981, and they represent 63 percent of total HMO enrollees, up from 12 percent in 1981.

The HMO business has shown a corresponding economic increase as well. The market capitalization of publicly traded HMOs grew from $3.3 billion in 1987 to $38.9 billion by the end of 1997.

Health care expenditures are forecast to continue to rise. In 1970, the nation spent $73.2 billion on health care. The government is projecting the nation will spend $1.29 trillion on health care in 2000, or 13.5 percent of the nation’s gross domestic product, the highest health care spending in the world.