Your browser doesn't support JavaScript. Please upgrade to a modern browser or enable JavaScript in your existing browser.
Skip Navigation U.S. Department of Health and Human Services
Agency for Healthcare Research Quality
Archive print banner

This information is for reference purposes only. It was current when produced and may now be outdated. Archive material is no longer maintained, and some links may not work. Persons with disabilities having difficulty accessing this information should contact us at: Let us know the nature of the problem, the Web address of what you want, and your contact information.

Please go to for current information.

Structuring Health Insurance Markets

Evolution of Health Insurance Markets


Len Nichols, Ph.D., Principle Research Associate, The Urban Institute, Washington, DC.

This opening presentation provided a context for later sessions by describing the basic theory of insurance markets and tracing their evolution. Dr. Nichols listed the conditions under which markets are most likely to perform well and compared actual health insurance markets against market theory.

In theory, markets generally are efficient when there are no barriers to entry or exit and when there is information symmetry. In health insurance markets it is fairly easy to obtain capital and to qualify for a license to provide health insurance. Hence there are low barriers to entry. However, information is asymmetric.

Dr. Nichols gave some examples of these asymmetries:

  • Between Enrollees and Insurers. Enrollees know more about their health than insurers complicating insurers' ability to project future utilization.
  • Between Providers and Insurers. There is a tendency for physicians to perform extra services to inflate the value they added to the patients' well-being. Information asymmetry puts the insurer at a disadvantage to challenge physicians' coding practices and practice patterns.
  • Between Providers and Patients. Patients don't really know what they need. They have to trust the physicians' knowledge base and discretion.

Dr. Nichols discussed other conditions in health insurance markets and said that the third party payment system leads to a tendency for excess demand and it lowers the price to the patient to below true marginal cost to the provider as well as to society. He also spoke about the distribution of expenditures being skewed wherein one percent of the population spends ten percent of the dollars, ten percent of the population spends 70 percent of the dollars, and the lowest cost 50 percent of the population spends about 31 percent of the dollars showing how you can profit by favorable risk selection.

In a discussion of the fundamental problems with health insurance markets, Dr. Nichols listed and defined the following terms:

  • Adverse Selection. When the sick seek coverage and the healthy do not.
  • Moral Hazard. When the insured's behavior is affected by the existence of insurance.
  • Stinting. When useful care is denied for profit.

Giving a brief history of the evolution of health insurance markets in the United States, Dr. Nichols discussed the rise and fall of indemnity insurance showing its dramatic rise from 1940 to 1980 and its subsequent fall by 1993 when self-insured plans plus health maintenance organizations (HMOs) surpassed commercial indemnity coverage by over 30 million people. He showed that both small and large firms shifted dramatically from indemnity into managed care plans between 1988 and 1996.

In highlighting the importance of the self-insured market, Dr. Nichols revealed that 20 percent of employers who offer coverage to employees are self-insured. But these relatively large firms account for 41 percent of all lives covered by employer-sponsored plans.


Nichols LM. July 1997. A Framework for Assessing Insurer Responses to Health Care Market Changes. Washington D.C.: The Urban Institute.

Wholey DR, Christianson JB, Engberg J, Bryce C. HMO Market Structure and Performance: 1985-1995. Health Affairs 16(6):75-84.

Bailit MH. Perspective: A Purchaser's View of Health Care Market Trends. Health Affairs 16(6):85-8.

Burns LR, Bazzoli GJ, Dynan L, Wholey DR. Managed Care, Market Stages, and Integrated Delivery Systems: Is There a Relationship? Health Affairs 16(6):204-18.

Evans RG. Going for the Gold: The Redistributive Agenda Behind Market-Based Health Care Reform. Journal of Health Politics, Policy and Law 22(2):427-65.

Gaynor M, Vogt WB. Commentary—What Does Economics Have to Say About Health Policy Anyway? A Comment and Correction on Evans and Rice. Journal of Health Politics, Policy and Law 22(2):475-96.

Hellinger FJ. Any Willing-Provider and Freedom of Choice Laws: An Economic Assessment. Health Affairs 14(4):297-302.

Pauly MV. Commentary—Who Was That Straw Man Anyway? Comment on Evans and Rice. Journal of Health Politics, Policy and Law 22(2):467-73.

Rice T. Can Markets Give Us the Health System We Want? Journal of Health Politics, Policy and Law 22(2):383-426.

Thorpe KE. The Health Systems in Transition: Care, Cost, and Coverage. Journal of Health Politics, Policy and Law 22(2):339-61.

Previous Section Previous Section         Contents         Next Section Next Section

The information on this page is archived and provided for reference purposes only.

AHRQ Advancing Excellence in Health Care