Health Care Financing History in the United States


The system of healthcare in the United States is dominated by fee-for-service model. However, the issue of rising healthcare costs and low quality of care led to the development of other payment models, some of which are claimed to have a positive effect on patient outcomes while reducing costs. In this paper, the researcher provides a brief overview of the history of healthcare financing in the United States and compares healthcare payment models to those used in other industries. In addition, the underlying causes of the transition from the fee-for-service model to value-based and outcome-based models are presented.

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Brief History of Health Care Financing

While the concept of private health insurance originated in the 19th century, the concept of social insurance was introduced only in the 1990s (Braverman, 2009). The first model of such insurance was supposed to offer compulsory health insurance for the working class and the poor but was denounced by various groups, including the commercial insurance industry (Braverman, 2009). At the time private insurance companies covered the cost of medical services using the fee-for-service model.

Rising healthcare costs and the negative economic effect of the Great Depression prompted the creation of prepayment services in the 1930s (Braverman, 2009). Low accessibility of medical care and its rising costs led to widespread adoption of prepaid hospitalization plans. In the 1940s, first physicians started to offer medical services on the prepaid basis (Braverman, 2009).

The foundation of a welfare medical program was the Social Security Act of 1935, which, after its expansion in the 1950s, allowed the state to pay directly to “physicians, nurses, and health care institutions”. At the same time, in response to rapidly rising healthcare costs, insurance companies introduced new types of insurance, including major medical, vision, extended-care, and dental insurance (Braverman, 2009).

After the introduction of Medicare and Medicaid, which prompted healthcare costs to rise dramatically, health maintenance organizations (HMOs) were created to contain costs. Such organizations provided medical services in exchange for a fixed annual fee and stressed outpatient care. In the 1970s, ERISA law was passed which encouraged self-insurance and prompted employees to ensure their workers directly to save costs. In the 1990s, the rising costs prompted businesses to turn to managed care, while preferred provider organizations (PPOs) were created as a less restrictive combination of fee-for-service and HMOs.

The Comparison of Payment Models

Recently, in the business environment, there has been a shift towards the reliance on pay-for-performance salary system, also known as pay-at-risk or variable pay. This payment system implies reducing the fixed salary component below market average but increasing the incentive component above it (Biswas, 2014). The incentive component is tied to employees’ performance and is used to motivate the rewarded behavior.

In pay-for-performance system, the better employees work, the higher their salary will be. Such payment model incentivizes the employees to work towards improving the company’s financial performance since it is tied to the employee’s individual compensation.

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In comparison to this model, the traditional fee-for-service model mainly used in healthcare emphasizes the quantity, rather than quality of services. In this payment model, the practitioner is paid for each health care service or procedure. This model is inflationary since the practitioner, and in some cases, the patient themselves, are paid by a third party and do not need to consider the cost of treatment. As a result, practitioners use more procedures and sometimes, perform unnecessary medical services, such as duplicate tests, to generate income.

The Shift towards Value-Based Models

The United States healthcare expenditures have been increasing at a faster rate than in any other country (Chandra & Skinner, 2012, p. 645). Rising healthcare costs are directly related to the increase in healthcare expenditures. The consumption of healthcare services has also been rising and contributed to the rising costs. The reason why healthcare consumption has been rising is due to the fee-for-service model, which incentivizes practitioners to provide more treatments.

The need to contain healthcare costs is the major factor which influences the shift towards pay-for-performance payment model. Also known as value-based payment model, it was introduced to address the inefficiencies of the fee-for-service model, mainly to contain costs and improve the quality of care. Value-based payment model suggests establishing certain quality metrics and incentivizing healthcare providers to provide quality medical care.

Another factor which contributes to the adoption of this model is the need to improve the quality of care. Since the traditional fee-for-service model does not incentivize providing quality care, it may be the reason why in spite of the rising expenditures the quality of care has remained low. Pay-for-performance payment model uses quality indicators to measure practitioners’ performance and penalizes them for poor outcomes.


It is evident that the system of healthcare in the United States is characterized by complex relationships between healthcare providers, insurance companies and the government. Main financing models include fee-for-service and pay-for-performance models. Healthcare industry is labor-dependent, has limited ability to contain costs due to the prevalence of fee-for-service model, and is experiencing a shift towards value-based financing models.


Biswas, B. (2014). Employee Benefits Design and Compensation (Collection). Upper Saddle River, New Jersey, United States: FT Press.

Braverman, J. (2009). Health Economics. London, United Kingdom: Pharmaceutical Press.

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Chandra, A., & Skinner, J. (2012). Technology Growth and Expenditure Growth in Health Care. Journal of Economic Literature, 50(3), 645-680. Web.

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