68: Managed Care and Psychiatry

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CHAPTER 68 Managed Care and Psychiatry


These two quotes outline the inherent dilemma in financing mental health care in the United States. On the one hand, mental illness is just like other corporeal diseases; it stems from biological underpinnings, it causes tremendous suffering, and it is (increasingly) responsive to treatment. On the other hand, mental illness is decidedly different in terms of its presentation, its patient population, and its perception by society. These differences from other medical conditions have led to the formation of a separate and sometimes unequal system of care delivery. This inherent dichotomy is at the root of current debates over the future of financing of mental health care (MHC).

In order to fully appreciate the forces guiding the financing of MHC, it is useful to consider the mix of social, medical, and financial dynamics that have led to the MHC system as we know it today. This interplay of forces has been particularly evident over the latter half of the twentieth century, with new treatments, deinstitutionalization, and rising costs leading to profound changes in how MHC is financed. Conversely, the rise of new institutional arrangements for the finance and delivery of services (such as managed behavioral health “carve-out” plans) have precipitated major changes in how patients are treated, both in the MHC delivery system and in the community. While these changes have led to significant reductions in inpatient psychiatric hospitalization, access to outpatient MHC has remained limited compared with general care, prompting advocates to call for mental health parity laws. Parity policies aim to equalize insurance coverage for mental illnesses and other medical conditions.

This chapter will discuss the history of MHC financing (including the formation of public and private health insurance in the United States), the evolution of managed MHC and the reasons for its growth, the current structure and attributes of MHC financing in the United States, and the controversy over MHC parity laws and their impact on the future of MHC delivery.


Throughout the history of the United States, social movements relating to the care of the mentally ill have altered the delivery and financing of MHC3 (Table 68-1). After the Revolutionary War, increasing urbanization led to the development of asylums for the mentally ill, most notably in Philadelphia (Pennsylvania) and Williamsburg (Virginia). Before the establishment of these state-run, state-financed psychiatric hospitals, local communities and families bore the brunt of the responsibility for caring for the mentally ill, initially through local almshouses (poorhouses) and then through more formalized financing methods. As the financial burden on localities increased over time, an effort was made to shift the costs of financing MHC to the states. A corollary goal supported by the psychiatric profession involved separating the financing of care for the mentally ill from local, charity-based indigent care.

A group of reformers (led by Horace Mann, among others) led the “moral treatment” movement, which advocated for the institutionalization of patients with the hopes that early treatment would lead to a resolution of their mental illness. The activist Dorthea Dix, in particular, was instrumental in lobbying state legislatures for the establishment of psychiatric hospitals. Eventually, each state developed its own asylum system in response to the movement. Over the course of the nineteenth century, asylums became overcrowded, and, as the promise of early intervention went largely unfulfilled, asylums became the permanent home to many chronically ill patients. Funding of asylums did not increase with the rise in the patient population. State and local governments were in conflict as to how to fund mental health services, with the latter often choosing to place the mentally ill in jail or in almshouses rather than pay for care at asylums.4 In the latter half of the nineteenth century, a new movement known as the “mental hygiene” movement sought to improve the conditions of patients in asylums. A number of federal laws, known as the State Care Acts, required states to pay for all asylum care, prompting localities to send an ever-increasing number of patients to asylums. Reformers from the National Committee on Mental Hygiene also advocated for treatment of mental illness in medical hospitals, as well as in outpatient settings, bringing MHC more into the medical model of care. This continued to be the case into the 1930s when a new method of private employer–based health insurance financing was born.5


The current system of employer-based health insurance, while accidental in its conception, has become entrenched as the primary way by which health care is financed in this country. Until the 1930s, private individuals paid out-of-pocket for health care services on a fee-for-service basis.6 During the 1930s, nonprofit Blue Cross/Blue Shield (BCBS) health insurance plans were developed and, despite skepticism as to their viability, were successful. Once health insurance was shown by the BCBS plans to be a financially feasible endeavor, a number of private for-profit health insurance companies were founded. During World War II, when the government allowed employers to offer health insurance in lieu of wage increases, private health insurers grew in both size and number, with the number of covered individuals rising from 20.6 million to 142 million between 1940 and 1950.6 Coverage expanded even further and became more tightly linked to employment contracts when, in 1954, the Internal Revenue Service (IRS) ruled that employer-based health insurance should not be considered as taxable income. While coverage was expanded for general medical care, MHC coverage was substantially more limited. Insurance policies did not include mental health services until after World War II, when insurers began covering some hospital-based psychiatric care. Before the deinstitutionalization movement (discussed in the next section), there was little incentive for private insurers to cover services that were already paid for through the public sector.7


With MHC becoming increasingly fragmented in the 1960s, a number of federal government insurance programs were established that would come to play a large role in providing care for the mentally ill.

Medicare was established in 1965 in response to the country’s growing number of senior citizens. Financed through federal payroll taxes, subsidized premiums, and general tax revenues, Medicare was designed to cover both inpatient (Part A) and outpatient (Part B) care. All individuals above age 65 were covered by Part A (regardless of income), and Part B, while optional, was quickly adopted by most beneficiaries given its relatively generous outpatient coverage for a relatively small fee. While there have been some changes in which treatments Medicare pays for (most notably the introduction of prescription drug coverage in 2003) and how it pays for them, its basic structure and benefits have stayed relatively consistent.

Medicaid was enacted through the same federal legislation that saw the enactment of Medicare. Its mission and structure were quite different from those of Medicare, however. One major difference was that Medicaid was designed to provide medical care to categorically eligible low-income children and adults as opposed to the elderly, who were covered by Medicare. Funding also differs between Medicaid and Medicare, with Medicaid being funded in part by states with the federal government matching state contributions. Although Medicaid enrollment is optional for states, all states have participated since 1982. Within broad federal guidelines states have a significant amount of control over eligibility as well as what services are covered. Medicaid offers enrollees a somewhat richer mental health benefit than Medicare.

The creation of Medicaid and Medicare had the practical effect of shifting a large number of elderly state mental hospital patients into federally financed general hospitals and nursing homes, thereby accelerating deinstitutionalization; since patients were often transferred to other types of institutions rather than to the community this transition has been called transhospitalization. Medicare and Medicaid would come to account for more than a third of all spending on mental health by 1991. While state hospitals would continue to serve as a last resort for the chronically mentally ill, their impact on MHC would pale in comparison to Medicaid, Medicare, and private health insurance as sources of support for the mentally ill.


With the provision of MHC increasingly financed by public and private insurance plans over the latter half of the twentieth century, economic problems inherent in the structure of the health care market became increasingly evident. From the mid-1960s until the early 1990s, health costs increased by an annual rate of 4.1%8 compared with a 1.5% increase in the gross domestic product (GDP). Such a rise was believed to be largely due to both a rise in technological advances, such as new drugs and devices and a health insurance market that was ineffective and inefficient at rationing care (with the latter allowing ever-increasing usage and total costs brought on in part by the former). In order to understand the rise of managed care plans and their impact on mental health, it is crucial to understand the “basic science” of health insurance that leads to difficulties with financing care.

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