(FORTUNE Magazine) – How can America spend more per capita on health care than any country on earth, and still be the only developed nation that leaves about 15% of its population uninsured? How can U.S. companies continue to afford medical bills that rise at more than twice the rate of inflation, and which in 1989 cost them $173 billion -- a sum equal to 100% of their net profits? How can even the world's richest country stay competitive when health care consumes 50% more of national output than it does in its closest rivals? No, the questions aren't new, but the urgency with which executives and politicians are seeking answers to them is. Suddenly Americans seem more ready to consider major health care reform than at any time since the early 1960s, when the country marshaled the moral outrage and political muscle required to launch Medicaid (to cover the poor) and Medicare (for the elderly). More than a dozen proposals to revamp the system are floating around Washington. In April, Budget Director Richard Darman shocked Capitol Hill by forecasting that unless a treatment is found, health care will consume 17% of GNP by the year 2000 -- more than the current shares of education, defense, and recreation combined. Who's got the best cure? Two types of remedy have grabbed most of the attention. The first, mandated care, essentially requires that all companies insure their employees or contribute to a federal fund that would cover the uninsured. In June, Senate Majority Leader George Mitchell and several top Democrats introduced a major bill pushing this idea. The second proposal is to replace the current patchwork system with a single, comprehensive plan, financed by taxpayers. The General Accounting Office has just issued a report claiming that switching to a national health insurance plan modeled on Canada's would save the U.S. $75 billion a year -- mainly by reducing the paperwork generated when 1,500 insurance companies, using a variety of claim forms and conditions, reimburse 6,000 hospitals and 600,000 physicians. In FORTUNE's view, however, the right answer is more likely to be found in a third approach, variations of which have been suggested by a few imaginative scholars. Call it the shrewd consumer model. In this scheme individuals would be responsible for buying their health insurance; government would help only those who cannot afford it. No major politician or lobby has yet embraced the idea, but it has a marketplace logic that deserves respect: If patients have to pay, their frugal shopping, rather than bureaucrats wielding red pencils, could be the mechanism that holds down costs. This special report will examine these alternatives and, in the following article, look at what corporations are doing. Business bears a special burden these days. Pinched by recession, federal and state governments, which account for roughly 40% of U.S. health spending, have been shaving reimbursements to doctors and hospitals. To maintain their incomes, the medical providers have, in turn, raised the bills they charge private payers. What's at the root of the unrivaled cost increases that threaten the stability of America's health care system? Self-destruction is part of it. Reckless pregnancies -- underclass mothers continuing their addiction to crack cocaine, for example -- explain the roughly 375,000 babies born every year who are exposed to illegal drugs. Some require as much as $200,000 in intensive care. But don't charge the cost of addiction to the ghetto's account alone. The fastest growing item on corporate medical bills is mental health care, caused in part by the alcohol and drug abuse of workers and executives and their families. Alcohol and tobacco, moreover, cost billions in lung cancer, heart disease, cirrhosis, and other ailments. Says Gail Wilensky, head of the federal agency that supervises Medicare and Medicaid financing: ''People want the health care system to undo all the damage they heap upon themselves.'' Other rising expenses seem inevitable. The cost of AIDS will almost certainly climb far beyond the roughly $7 billion that will be spent this year to care for the 175,000 victims currently diagnosed. The virus may have infected more than one million Americans. Paradoxically, because medicine helps Americans live longer, they now spend far more years being sick. Doctors rescue an 80-year-old from pneumonia and a year later he winds up in a nursing home with Alzheimer's disease. One-third of the $62 billion paid by Medicaid in 1989 was sent to such homes to support the elderly poor, many of whom are ex-members of the middle class who either exhausted their savings or gave them away to their children. The number of those over 75, the age at which many people's health starts to deteriorate rapidly, has increased from 5.6 million 30 years ago to 13.2 million today. When the first of the baby-boomers reach this frontier in 2020, they are likely to swell the ranks to 21 million. TECHNOLOGY CREEP is as persistent as staph infection, and adds to expenses, not necessarily productivity. New instruments supplement rather than replace old ones and breed attendants and interpreters by the thousands. A new MRI (magnetic resonance imager) costs about $2 million installed. A $200,000-a- year radiologist divines what the pictures mean. So hospitals charge up to $1,000 for an MRI scan. And while it takes crisp pictures of brains, spinal cords, and joints, the MRI is fuzzy on chests and abdomens, so it hasn't displaced the $1 million CAT (computerized axial tomography) scanner. Brace yourself. The latest in viewers is the PET (positron emission tomography), which can watch chemical changes take place within the body -- helpful in identifying Parkinson's disease, for one. Because it requires its own cyclotron to produce a radioactive gas that the patient inhales (or a liquid injected into his vein), a PET rig takes a $5 million bite out of any hospital's budget. For now only 40 or so of these machines are in use, mostly for research. But the number will grow. ''Insurance companies will be paying at least $2,500 a shot,'' says Dr. Roger Herdman, medical director of Congress's Office of Technology Assessment. Such medicine does save lives. But the excess in the U.S. system is extraordinary -- piles of paperwork, enormous liability awards, surplus hospital rooms, redundant teams of high-priced specialists, too much surgery, and far too many copies of the same piece of high-tech equipment. The U.S., for example, has 2,000 MRIs; Canada, only 15. Robert Brook, director of health sciences research for the Rand Corp., estimates that as much as one-third of American medical spending is unnecessary. Eliminating even a fraction of the waste, he figures, would save more than the $15 billion it would take to extend coverage to the uninsured. DOCTORS PAY OVER $5 billion a year for malpractice insurance, which compensates victims fairly at times and with stupefying generosity at others. Two years ago a Los Angeles court decided a couple was entitled to $54 million because their baby suffered brain damage during an X-ray. President Bush has recently proposed that states limit awards for pain and suffering to $250,000 per case. Even that might not uproot the hidden expense of liability. To protect themselves from lawsuits, doctors order MRI scans, blood tests, and such even when they are only remotely relevant. The American Medical Association figures defensive medicine costs $15 billion a year. A common perspective on American-style health care is that patient demand drives it. ''We all want access to the latest technology, the doctor of our choice, and no waiting,'' says Don Moran, a Washington consultant on health policy. ''These are luxuries, but we think of them as necessities.'' Or as Dr. Alan R. Hudson, president of the Toronto Hospital, puts it bluntly: ''When an American hits his head on the road, he expects a neurosurgeon to be standing there.'' No doubt, American consumers are somewhat spoiled. But an impressive amount of evidence suggests that it is not so much patient demand as local medical practices and the oversupply of hospitals and specialists that determine how much care is dispensed. Dr. John Wennberg of Dartmouth Medical School calculates that residents of Boston, home of several renowned medical institutions, spend twice as much per capita on treatment as citizens of New Haven -- with no discernible differences in their health. A General Motors study reveals that, on average, a worker in Youngstown, Ohio pays twice the medical bills of one in Grand Rapids, Michigan, only 200 miles away. The extra treatment adds roughly $1 an hour to GM's labor costs. Says Beach Hall, a GM director who monitors health costs: ''I have told the medical establishment in Youngstown that if this continues, it could be endangering the company's future in the community.'' Too much hospital capacity also creates incentives for excessive treatment. A building spree in the 1970s was followed in the late 1980s by pressure from Medicare to discharge patients quickly. So the U.S. occupancy rate has fallen to 65%, vs. 87% in Germany and 81% in Canada. As a result, hospitals try to attract doctors who will bring in patients likely to run up substantial bills. Dr. Robert Lester, a physician at Sunnybrook medical center in Toronto, recalls touring a couple of U.S. East Coast hospitals not long ago. One hospital administrator reminded doctors of what a promising client the heart patient is, because he can be sold a procedure or two from a long product line: an angioplasty, in which a tube is inserted into an artery to clean out a blockage (cost: about $15,000); a coronary artery bypass graft ($40,000); a heart valve replacement ($50,000); and a heart transplant ($100,000). Take a look at a place like Kansas City, where Heartland U.S.A. has taken on a new meaning. No fewer than 14 hospitals perform bypasses and valve | replacements for its 1.6 million residents. Only five hospitals in Toronto, with a population of 3.4 million, do that kind of work. St. Luke's in Kansas City boasts in its radio commercials that it performed more than 2,000 angioplasties last year. ''Angioplasties 'R' Us,'' quips a local newspaper reporter. St. Luke's and the University of Kansas medical center replace hearts as well. For those who have lost track of the proliferation of this exotic surgery: An astounding 151 hospitals in the U.S. now replace hearts, compared with 11 in Canada and 19 in Germany. CONVENIENT, but crazy. Both Kansas City hospitals, for example, have to maintain teams of specialists to help patients through the dangerous period in which the body tries to destroy the alien organ. Economies of scale as well as safety -- constant practice makes better -- suggest that the two university programs should consolidate. But neither is willing to pull down its shingle and send customers across town. ''There are a lot of egos involved in this,'' admits George E. Hayes, St. Luke's senior associate director. Not to mention incomes. Across the U.S., surgeons performed 350,000 bypasses last year for total billings of about $14 billion. How many were necessary? Rand researcher Brook studied 300 patients who had undergone bypasses at several California hospitals and concluded that a bare majority of the operations were clearly justified, relieving chest pains or prolonging life better than drugs. But 14% of the patients would have thrived as well on drugs, without risking surgery, and 30% were borderline. Few physicians would endanger a patient's life needlessly just to be able to send a bill, but in borderline cases finances can be a factor. ''Like anybody else, a cardiac surgeon wants to maintain his income,'' says Dr. Arnold Relman, a nephrologist and editor of the New England Journal of Medicine. Last year the U.S.'s 2,107 cardiovascular surgeons earned on average $300,000, after deducting office expenses. St. Luke's charged Medicare $2,950 in 1989 for probing and clearing a patient's arteries; a neighboring medical center charged $5,029. Market forces that eliminate inefficient businesses elsewhere in the economy are flabby in the medical field. The expensive hospital survives because a company, Hallmark for example, allows its employees to get treatment pretty much where they like. So there is little incentive for a Hallmark poet or account manager to seek out the best buy in Kansas City bypasses. The question is, what systemic reform will squeeze out the waste -- the questionable bypasses, automatic MRI scans, gadgets, and tests that improve care only minutely -- and still guarantee quality care to all? Mandated care, which has been backed by the American Medical Association as well as by leading Democrats such as Ted Kennedy, would give the 35 million uninsured the basic medical protection the insured have -- a worthwhile achievement. But it could shrink or close a lot of small businesses that couldn't pay the premiums. Also, because it expands the current health system, mandated care would bring more people into hospitals for more overtreatment. Without rigid price controls, which the AMA naturally opposes, such a change would raise costs, not lower them. Senator Bob Kerrey of Nebraska, a possible contender for the Democratic presidential nomination, favors national health insurance, and even some business executives agree it ought to be considered (see CEO Poll). In Canada, typically 10% of a citizen's income goes to a tax fund that pays for health care. A patient picks the physician of his or her choice, who charges the government -- after performing the service -- according to a schedule. For example, $200 pays for a routine delivery. (An obstetrician in Kansas City charges about $1,500.) Provincial governments allocate funds to hospitals according to a formula that includes the number of patients treated. Hospitals must stay within their budgets, which makes them prudent about dispatching borderline cases to the operating room for a fast bypass. The patient never sees a bill, except for TV and telephone rental, or roughly $150 a day for a private room. IF THE U.S. WENT DOWN this route, it would mean shifting $300 billion a year -- another Defense Department -- onto the federal budget. Chances are, Washington would buy more health care than it would collect taxes for, and the deficit would go into deep trauma. Reducing paperwork and the number of hospitals would bring the cost down, but politicians don't have much talent for padlocking. Hospitals don't simply save lives; they provide jobs. Consider how difficult it has been to close surplus military bases. Even in Canada, the health plan is under considerable strain. Canada had a bigger federal budget deficit per capita than the U.S. last year -- $1,100 vs. America's $940 -- and some of the same forces, such as a graying population and new technology, are pushing medical expenditures against the ceiling. Gunshot and knifing victims are rare, so a Canadian hospital is a tidier, calmer place than its American counterpart. But it isn't hard to detect a quiet crisis. On a recent afternoon at Toronto's fully booked Sunnybrook medical center, half a dozen elderly patients lie on stretchers in the emergency room waiting for real beds. At nearby Toronto Hospital, President Alan Hudson worries about budget constraints. ''Before the end of the year,'' he predicts, ''there will be a headline charging that we have a heart donor and a heart recipient and not enough money to do a transplant.'' Already thousands of Canadians who are at serious risk or just tired of waiting in line hop over the border to Buffalo or Detroit. If Canada considers such care urgent and not available at home, it will reimburse the American hospital. Its ability to evacuate some of its sick to the U.S. -- and take advantage of the $19 billion a year the U.S. spends on research -- helps keep this small country's tight ship afloat. But it's one more reason to be cautious about copying Canada's system. America has no medic of last resort. Another alternative is Germany's health plan, which has gotten less attention but works more smoothly. All Germany is divided into 1,000 or so sickness funds, akin to the health maintenance organizations that 37 million Americans belong to. Each German city and town has at least one, and everyone below a certain income level must join. Depending on his income, a corporate employee puts up to $2,000 of salary into the fund and his employer matches it, much like Social Security in the U.S. Other payroll deductions cover the retired and unemployed. Sickness funds then negotiate with regional medical associations over services and price. Like Canadians, Germans can go to the doctors and hospitals of their choice and pay nothing, except some small change for drugs. Though treatment is sometimes brusque, surveys indicate that Germans are, on balance, much happier with their health care system than Canadians or Americans. Germans are also more disposed to listen respectfully to their physicians and rarely sue them, and German doctors settle for lower wages. Would Americans accept the German plan? Perhaps, but it isn't clear that the American character would take to a system that depends on voluntary restraint. The German government, moreover, limits the number of training slots | allotted to specialists, sometimes with disastrous results. Dr. Isabelle Richmond, a neurosurgeon who worked for the U.S. Army in the 1980s, examined dozens of soldiers and dependents who suffered brain tumors, head wounds, and other serious injuries while stationed in Germany. Because the country has relatively few neurosurgeons, some of the victims were operated on by general surgeons, who have little training in the difficult art of repairing brains and spinal cords. Claims Richmond: ''Patients who in the U.S. would have been restored to functioning people were left as gorks.'' MAYBE THE U.S. health crisis requires an American solution, one that appeals to the spirit of self-reliance. Regina Herzlinger, a Harvard business school professor, has surveyed several hundred large companies and their health care advisers. Her conclusion: Each adult American, whether self-employed or on a payroll, should be forced to shop for his own insurance. In Herzlinger's scheme, everyone would have to buy policies that would reimburse him for any medical expenses greater than 5% of his salary, so doctors and hospitals would not get stuck with the expense of treating catastrophic injuries or illnesses. Spending for premiums up to a set amount -- say, the $3,100 per employee that companies now spend on insurance -- would be made tax-deductible. While everyone would share in this tax break, the big corporations that used to monopolize it might well choose to make the transition painless for workers by increasing their annual paychecks by a like amount. All taxpayers would have to show on their returns that they have purchased insurance, which would discourage those tempted to bet they won't get sick. One final mandatory element: Insurers would be required to take a share of high-risk clients, such as those with a history of serious illness. Beyond these basics, people would be free to buy the policies of their choice from a variety of insurance companies. What about the poor and unemployed? Other scholars have suggested that government could give them tax credits to pay for their insurance needs, just as many Americans who earn less than $11,250 a year now get checks from Washington for up to $1,235. This tax credit could gradually replace Medicaid and Medicare. How would this reform hold down costs? Return now to Kansas City. Under such a system, insurance companies would likely offer moderately priced policies that would restrict customers to having their heart surgery at St. Luke's or the University of Kansas and not at one of their high-priced competitors. Licensed nurse-midwives would deliver babies in low-tech maternity centers, with the understanding that specialists would take over in the case of the one pregnancy in five that is worrisome. The shrewd-consumer strategy is not a guaranteed success. The prospect of counting on millions of consumers to make informed decisions about a field in which technology changes rapidly is a little daunting, since the consequences are more serious than buying a bum computer. Herzlinger insists there is little need to worry. ''Americans are tremendously astute about health insurance,'' she maintains. ''And services would spring up to give or sell them advice.'' The way to start would be to begin experimenting with this idea in a few dozen communities. THOUGH PRESSURE is mounting, don't look for Congress to pass any major health care reform this year. White House leadership will be required to overcome the legislators' own internal divisions as well as fierce lobbying from powerful interest groups -- the old folks lobbies, the doctors, the insurers. George Bush has indicated he would rather wait until at least next year to unveil his preferred reform. But health care is likely to emerge as a central issue in the 1992 campaign, and with luck, the country will start 1993 with a clear-headed program. Predicts Carson Beadle, managing director of William M. Mercer, an employee benefits consulting firm: ''The launching pad for America's future health system is going to take shape over the next 18 months.'' If it doesn't -- or if we get it wrong -- then the only thing certain to reach the stars will be health care's share of U.S. GNP.

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART/SOURCE: HEALTH AFFAIRS CAPTION: OUT OF CONTROL

CHART: NOT AVAILABLE CREDIT: FORTUNE CHART CAPTION: WHO PAYS THE BILLS? The sheer complexity of the American system adds an estimated $75 billion a year in paperwork costs.