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Unformatted text preview: Health Insurance and Market Failure since Arrow Sherry A. Glied Columbia University Illness is usually unexpected and often costly. Health insurance is a con- tingent claims contract that moves funds from the usual state of the world, when one is healthy, to the unexpected and costly state, when one is ill. In this sense, it is a market success: an institutional response to a natural feature of the demand for health care. Without such an institu- tion, there would be no market to transfer funds between health states. In its operation, however, health insurance introduces its own set of market failures. The key features of the health insurance institutions we observe now are, in turn, responses to the existence of these market failures. This recursive relationship between institutions and market failure is a core organizing theme of Arrows article. Arrow described institutional arrangements in health care as responses to the market failures of his time. Strikingly, to a reader in 2001, Arrow gave health insurance relatively little airplay in his article. Instead, Arrow devoted the bulk of his essay to the training and organization of profes- sionals and the nature of hospitals. Today, most writers would view the topics Arrow stressed as largely secondary in importance to the organi- zation and nature of health insurance in explaining the functioning of the health care system as a whole. Health insurance, a source of market fail- ure on its own, has now become a central force in addressing the other market failures Arrow identified throughout the health care market. The purpose of this article is to build on Arrows work in examining the evolution of insurance institutions in response to the market failures Journal of Health Politics, Policy and Law , Vol. 26, No. 5, October 2001. Copyright 2001 by Duke University Press. that arise in individual insurance contracts and in the market for health insurance. This institutional evolution, in turn, explains why health insur- ance moved from the periphery to the core of the health care sector. Finally, this evolution also illuminates where private market institutions can, and where they cannot, effectively address insurance market failures. Arrow on Insurance Arrow addressed two aspects of health insurance in his 1963 article (and in his 1965 response to comments on it): the form of insurance contracts and the functioning of the insurance market. With respect to the form of insurance, he noted that the scope of insur- ance coverage was limited. Insurance arises to cover unexpected events, so health insurance sensibly did not typically cover services that were predictable, such as maternity care. Arrow also pointed out that there was little insurance available for illness-related disabilities. He explained these limitations of insurance contracts as a market response to moral hazard, which leads to expanded utilization in the presence of insurance....
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- Spring '11