Pricing and payment for medical care in the United States have always been complex, shaped by a patchwork of competing interests, evolving technologies, and shifting policy landscapes. In 1892, the Chicago Medical Society advised its members that it was appropriate to charge between $2.00 and $5.00 for a basic office consultation. More complex visits—”requiring manipulation, use of instruments or topical applications, as for diseases of the eye, ear, throat, nose, urethra, bladder, uterus, rectum, or suppurating cavities, redressing of wounds, [or] re-adjustment of splints”—could justify a fee as high as $25.00.
Even then, the public suspected medical costs were influenced by more than just clinical complexity. A satirical cartoon published in 1897 somewhat cheekily captured the elasticity of physician pricing. In it, a doctor sits before a fee schedule with columns labeled “Ailments for People of Moderate Means. Low Fees” and “Same Ailments for Rich Patients. Fees Accordingly.” The imagined price list allows for the same complaint to be billed as an “earache” for $5.00 or as “otitis media” for $250.00, depending upon a patient’s ability to pay.
While physician autonomy in setting fees once defined American medical practice, the twentieth century ushered in a profound shift, culminating in a reimbursement system shaped by federal policy and regulatory frameworks.
Defining Reimbursement
Of course, pricing is only one component of reimbursement, which the American Medical Association defines as a payment made by a third party—most often an insurer or government program—to a healthcare provider for services rendered. Unlike direct payments in conventional commercial transactions, reimbursement involves a system of financial arrangements aimed at balancing patient access, provider compensation, and cost control.
Reimbursement is distinct from cost or charge. Cost refers to the expense incurred by providers, hospitals, or medical device manufacturers to deliver care or produce medical technologies. It may include labor, supplies, research and development, facility overhead, manufacturing, and other operational expenses. A charge is the amount billed by providers for services. Providers set charges for services based on several factors, including costs incurred, the need to offset potential losses, and, as depicted in our cartoon, assumptions about a patient’s or insurer’s capacity to pay. To protect financial stability, providers may set charges higher than anticipated reimbursement, allowing room for negotiation with payers and accommodating scenarios where full payment may not be received.
Reimbursement is the amount ultimately paid to providers by payers, which may be private insurance plans or government programs. It may be a negotiated or predetermined rate and differ substantially from the original charge or the underlying cost.
The Rise of Private Insurance
In the early 20th century, American healthcare primarily operated on a fee-for-service model. Hospitals and physicians set charges based on actual costs, medical society guidelines, and what the market would bear. Patients receiving care outside of charitable or tax-supported facilities typically paid out-of-pocket, often making installment arrangements when necessary to cover their obligations.
By the 1920s, hospitals were expanding rapidly, spurred by economic growth and advancements in medical technology. However, the pace of expansion soon outstripped demand. The economic downturn that would culminate in the Great Depression left many hospitals financially strained and many Americans unable to afford care.
Recognizing these challenges, Dr. Justin Ford Kimball, then executive vice-president of Baylor University in Dallas, Texas, introduced a prepaid hospital insurance plan to provide affordable coverage for local schoolteachers. Building on a benefit fund Kimball had previously established for Dallas teachers, the plan offered up to 21 days of hospital care annually in exchange for monthly contributions of 50 cents. While the program initially operated at a loss, it provided Baylor Hospital with a predictable revenue stream and helped reduce losses from unpaid bills.
The Hospital Council of Essex County, New Jersey, expanded upon Kimball’s model by developing a county-wide plan that allowed members to receive care at any of several participating hospitals. This broader access addressed the limitations of single-hospital plans and contributed to the financial stability of participating institutions. The success of these early prepaid plans laid the groundwork for the development of Blue Cross.
Prepaid hospital plans like Blue Cross proliferated during the late 1920s and early 1930s. These plans provided enrollees with coverage for a specified range of services in exchange for regular payments. Initially limited to hospital care, these plans gradually expanded to include outpatient services as the cost and complexity of those services grew.
The Coordination of Blue Cross and Blue Shield
By the 1940s, the American Hospital Association was increasingly coordinating Blue Cross plans, seeking to reduce price competition among hospitals and ensure broader access to care. Through this coordination, Blue Cross established standardized rates for covered services and negotiated contracts directly with hospitals, promoting financial stability across the healthcare system.
Around the same time, Blue Shield plans emerged to cover physician services. Unlike the prepaid hospital plans offered by Blue Cross, Blue Shield plans typically reimbursed doctors based on their usual, customary, and reasonable (UCR) fees—a model that allowed physicians considerable discretion in setting prices within broadly accepted norms. Under UCR models, insurers covered a portion of the physician’s fees deemed reasonable based on prevailing charges for similar services within a geographic area. Patients were responsible for the balance.
These foundational models for private health insurance in the United States set the stage for broader shifts toward standardized reimbursement mechanisms.
Reinforcement Through Federal Policy
Importantly, while health insurance plans originated in the private and non-profit sectors, their role in U.S. healthcare was cemented through federal tax policy. During the Second World War, President Franklin D. Roosevelt exercised authority granted under the Stabilization Act of 1942 to prohibit private employers from increasing workers’ wages. As a result, employers increasingly relied on fringe benefits, including health insurance, to attract prospective employees despite wage controls. By the time the Internal Revenue Service confirmed in 1954 that employer-sponsored health insurance benefits were exempt from taxation, an American “system” of employer-sponsored health insurance had effectively taken root.
The Stage is Set
By the late 1950s, private insurance models based on prepaid hospital plans and UCR fees for physicians were well-established across the United States. However, the mechanisms by which costs, charges, and reimbursements were determined remained largely informal and varied significantly depending on location, insurer, and provider.
The expansion of private insurance left two critical gaps in coverage: there were no protections in place for retired and low-income populations.
In the next installment of our series on reimbursement, we will explore how establishing Medicare and Medicaid made the federal government a central payer for medical services and fundamentally reshaped reimbursement.