by Lars Powell
Posted 5/20/2013 12:00 am
Updated 10 months ago
When government and commerce collide, it can leave behind sticky residue that economists call inefficiency. Decades of academic studies pose theories and parse terabytes of data to determine why this happens and how much it costs. The insurance industry stands out in the economic literature as a frequent loser among regulated sectors.
While some industries, like fossil fuels and pharmaceuticals, have been shown to earn a good return on lobbying expenses, insurers do not. Insurers spend plenty on lobbyists. They just don’t seem to get as much bang for their buck. There are several reasons for this that might surprise readers.
Industries that get their way in public policy tend to have three characteristics in common. First, they are relatively easy to understand. Second, they are frequently on the minds of consumers and voters. Finally, their issues are politically urgent, meaning they will affect people in a positive way before the next election.
In sharp contrast, insurance is complex, rarely salient to consumers and struggles to communicate urgency for any positive development.
Insurance is the only industry in which companies must price their products before they know what the costs will be. To deal with such uncertainties, actuaries must pass examinations similar to doctoral degrees in finance and math before they are permitted to price insurance or estimate expected losses. It is not surprising that everyone I meet believes they pay too much for insurance, but insurers earn quite modest returns when compared to other industries. I cannot think of a more complex industry.
Perhaps this is why the insurance industry suffers from such a poor image. In a 2011 poll, 39 percent of Americans expressed trust in insurance companies. Only the federal government (31 percent) scored lower.
Unlike the prescription drugs we take or the fuel we use in our cars, we only think about insurance when we have a claim or when the price changes. Because insurance is designed to respond to rare events, few of us ever need to learn the complex details of insurance. When we do think of insurance, it is as a nebulous expense without an obvious connection to our daily routine.
Timing and lack of urgency present some of the toughest problems for insurers in public policy. A short-term solution to most insurance problems is for a regulator to arbitrarily cap the price of insurance. However, long-term regulatory price suppression hurts consumers. There are obvious examples in automobile insurance (Massachusetts, California, North Carolina et al.), hurricane coverage (Florida) and earthquake coverage (California), just to name a few. In each of these cases, state markets for insurance contracted in response to price controls until consumers were left with few choices, poor service and high prices. When government distorts market outcomes, it should not surprise anyone that the “solution” may be worse than the problem itself.
Arkansas has historically enjoyed robust insurance markets for most types of coverage. In a recent release of auto insurance data, there were zero drivers in Arkansas who could not find automobile insurance in the private market, compared with nearly 1.5 million drivers in North Carolina, where insurance prices are heavily regulated. Health insurance is also less expensive here than in most states.
Nonetheless, we must beware of misguided public policy. Insurance-bashing has always been a winning strategy for politicians. It is much easier to blame a complex industry than to address root causes of difficult problems — like the cost of health care. We can learn an important lesson from political history in New York. When U.S. Attorney Rudy Giuliani took down organized crime in his state, the people elected him mayor of New York City. Years later, when Attorney General Eliot Spitzer clobbered the insurance industry — including several convictions for false charges — voters made him governor. I don’t think insurance is really a worse problem than organized crime. It is simply harder for us to understand.
If you have a problem with your insurance, the best solution often is to shop around and let the market solve your problem before seeking help from the government. More importantly, when someone asks for your support on an insurance issue, invest the time to study the issue.
Lars Powell is the Whitbeck-Beyer Professor of Insurance & Financial Services in the Department of Economics & Finance at the University of Arkansas at Little Rock College of Business.