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Structuring Health Insurance Markets
Evolution of Health Insurance Markets
Len Nichols, Ph.D., Principle Research Associate, The Urban Institute, Washington,
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
- 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
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.
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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.
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