Managed care is a structured system designed to integrate the financing and delivery of healthcare services. Its primary goal is to control escalating costs and improve the quality of care by managing patient access and modifying how providers are paid. This system developed as a direct response to fundamental failures in the traditional healthcare model that led to unchecked spending and a fragmented patient experience.
The Economic Crisis of Fee-For-Service
The healthcare system in the United States before the 1970s was dominated by a fee-for-service (FFS) model, which financially rewarded providers for volume over value. Under this arrangement, doctors and hospitals were paid a separate fee for every test, procedure, and day of hospitalization. This structure created an incentive for overtreatment, encouraging unnecessary services and prolonged patient stays.
The result was severe medical inflation, particularly in the late 1960s and early 1970s. During the 1966 to 1973 period, national health expenditures accelerated to an average annual growth rate of 11.9 percent. This rapid growth meant that medical care prices were rising much faster than the general consumer price index.
The introduction of the Medicare and Medicaid programs in 1965 dramatically exacerbated this cost crisis. These government programs increased the demand for services by extending coverage to millions of elderly and low-income citizens. Because these programs operated on the existing FFS payment model, they poured vast new resources into a system that lacked meaningful cost controls.
The massive financial risk from this unrestrained spending was transferred to the government and to employers, who sponsored the majority of private health insurance. The federal government’s share of health expenditures grew substantially, while private sector payers faced unsustainable annual premium increases. By the early 1970s, the FFS structure was clearly financially unstable, setting the stage for policy intervention.
The Legislative Push for Health Maintenance Organizations
Policy makers recognized that simply capping hospital or physician fees was an insufficient long-term solution to the systemic problem of overutilization. The federal response was to introduce a new organizational structure that would embed cost control directly into the delivery model. This effort culminated in the passage of the Health Maintenance Organization Act of 1973 (Public Law 93-222).
This legislation was signed by President Richard Nixon, whose administration sought a market-based solution to curb medical inflation. The Act provided federal grants and loans to encourage the development of these new organizations, which were based on a prepaid, risk-sharing framework. It aimed to legitimize and promote the concept of prepaid group practices.
The most powerful provision was the “dual choice” mandate. This required employers with 25 or more employees offering a traditional health plan to also offer a federally qualified HMO option, if available. This mandate forced the new organizational model into the mainstream employee benefits market, ensuring its rapid expansion.
Core Mechanisms for Managing Utilization and Risk
Managed care plans implemented specific financial and administrative tools designed to directly counter the incentives of the FFS model. These mechanisms shifted financial risk away from the payer and put controls on the use of expensive services.
Capitation
One defining financial mechanism is capitation, where the provider is paid a fixed amount per patient per month, regardless of services used. This shifts the financial risk from the insurer to the provider, creating an incentive for efficiency and preventative care. For instance, a primary care physician (PCP) might receive a set fee per member per month to manage general medical needs.
The Gatekeeper
Managed care also introduced the concept of the gatekeeper, typically a PCP, who coordinates and authorizes all specialty and auxiliary medical services. This structure ensures that patient access to expensive specialists, imaging, and hospital stays is medically necessary and appropriately triaged. The gatekeeper role prevents the self-referral and unnecessary specialist visits common under FFS.
Utilization Review (UR)
Utilization review (UR) became a standardized administrative process to evaluate the appropriateness and necessity of care. This review includes prospective methods, such as prior authorization, which requires approval before an expensive procedure or hospital admission. It also involves concurrent review, which monitors necessity while a patient is hospitalized, and retrospective review, which assesses care after delivery.