Insurance and the Government: Partners in America
By Kurt Fuller
[Editor's Note: The author of this article has been professionally involved in the insurance business for over 27 years. In August 1996, he founded and became president and CEO of the Michigan Insurance Company of Grand Rapids, MI, which currently has over $ 73 million of premium writings. Mr. Fuller earned a B.B.A. from the University of Iowa, an M.B.A. from the University of Michigan, and the CPCU (Chartered Property and Casualty Underwriter) designation. He has published two previous pieces in The Voluntaryist (in Whole Nos. 114 and 115).]
Insurance is an enormously large industry in the United States. In exchange for a monetary payment (the premium), one party (the insurer) will assume some of the risk faced by another party (the insured). Virtually any type of risk can be insured, such as losses relating to your death, your car, your house, your teeth, a satellite, Tiger Woods, the Mona Lisa, and a hole-in-one charity event. While some people are repulsed by the thought of purchasing insurance, the reality is that our lives and lifestyles would be very different without it.
If insurance did not exist, it would be immensely more difficult to get a mortgage to purchase a house, or a loan to buy a car. Most lenders would not want to take the risk of their collateral disappearing and be left "holding the bag." It doesn't mean that houses and cars would not exist, it simply means that there would be far fewer of them. It doesn't mean that we wouldn't have teeth; they just would not be as well cared for. It doesn't mean that we wouldn't have beautiful, rare paintings, but there would be fewer of them, and they might not be displayed as frequently in public.
If insurance is such an integral part of our lives, then why is it not embraced by the public as a godsend, and why are premiums not paid enthusiastically? Why does the public demand that government regulate the insurance industry so that the consumer is protected? Why do consumers generally feel that they are being ripped off by the insurance industry, despite the heavy regulation? Why are the insurance carriers perceived as always trying to worm their way out of paying when something goes wrong; why do rates increase, even when you have a good claims record?
The answers to these and most other questions regarding the workings of the insurance business are hidden behind a façade. To the naked eye, the government and the insurance industry are in constant battle, with the government tirelessly working to protect the consumer, and the industry tirelessly working to fleece the consumer (its customers). Behind the façade is a fascinating partnership between the government and insurance companies.
What? How can these "mortal enemies" be partners? How can the government be partners with the evil perpetrators of public misery? And how can insurance companies be partners with the entity that is suppressing its revenues, working to expand the scope of its claims payments, and increasing expenses through compliance with the bureaucracy? This must be a misprint.
Sadly, it is not a misprint. In actuality, the partnership works very well, and allows both partners to flourish. How does it do this? Let's first look at the history of the partnership and see how we got where we are today.
The insurance business in the United States was marked by instability during much of the 19th Century. Companies were generally undercapitalized and ratemaking was mostly guesswork (because there was no historical loss data). The result was that the majority of companies went bankrupt, and many customers were left with large, unpaid claims.1
It is not hard to imagine that customers who suffered large losses (such as a house burning down) believed the government should step in and "do something" about this problem. At the same time, the surviving insurance companies were only too willing to accept "help" from the government in keeping their businesses solvent, in the name of protecting the consumer.2
This was the beginning of the insurance/government partnership.
The stated reasons for government involvement in the insurance business have not changed much since then. A recent article in the Florida State University Law Review, entitled "Insurance Regulation in the United States," stated that:
Regulation of the insurance industry is necessary. As the United States Supreme Court has long recognized, insurance is a business coupled with a public interest. Consumers invest substantial sums in insurance coverage in advance, but the value of the insurance lies in the future performance of the various contingent obligations. Because the interests protected are so important–including an individual's future ability to provide for dependents in case of death or injury, to retire, to obtain necessary medical treatment, to replace damaged or destroyed property–regulation of the industry furthers public welfare.
Related reasons for regulation center on the complexity of insurance, and consumers' inability to obtain and understand information about insurance. Consumers are ill-equipped to assess a company's future solvency, to compare the coverage of various policies, or to evaluate a company's claims service. Theoretically, government regulation of insurance eliminates these problems. Regulation can ensure solvency and the insurer's ability to pay claims in the future, standardize policy coverage, require minimum coverage, and require fair claims processing.
An equally important justification for insurance regulation is the prevention of excessive and potentially destructive competition. Because an insurance company's real costs are not known until an insurance policy matures and all claims are paid, the insurance business tends toward extreme competition in pricing. If the insurer's insolvency results, the consequences for the insured and their beneficiaries may be devastating.3
These three paragraphs summarize the general beliefs about insurance regulation. In this context, is it any wonder that the insurance/government partnership developed and flourished? Why would you want it any other way?
Now that the "need" for the partnership has been established, let's look at what each of the partners gets out of the deal:
What the government gets:
- A piece of the action
- Support for more bureaucracy
A Piece of the Action
The government benefits tremendously in its relationship with the industry through various methods of extracting taxes and "assessments." The easiest and most obvious is direct premium taxes, which are usually collected state governments, and are typically based on a percentage of the customers' premiums. What better way to be your partner than to get a piece of every dollar you bring in? There are literally dozens of other less visible and clever "assessments" for things like "auto theft prevention," "second injury," "silicosis and dust," "insurance company insolvency," and "assigned risk pools." In short, the revenue spigot is wide open from the industry to the government.
Support for More Bureaucracy
Along with all the "assessments" comes the need for "regulatory oversight." What good is an "auto theft prevention" fund without a bureaucracy to administer it? Every revenue source, assessment, or tax provides the excuse to further regulate, which is the code word for further expansion of the bureaucracy. While bureaucrats have little in common with business people, the one trait they share is the desire to expand their empire.
Once the government has all the clever schemes and "regulatory oversight" in place, they are in great position to proclaim their success in "protecting the public." They have slain the giant, and we are all safe again. Yes, we are humble public servants, but we do it all for you. How noble and altruistic! It sure sounds like we need these "helpers" in our life to make sure everything is OK.4
What the companies get:
- Protection from competition
- Protection from innovation
Protection from Competition
If you ask the CEO's of all the companies in the US whether they believe in free markets and the value of competition, they will all emphatically answer in the positive. However, if you ask whether they support specific measures that will eliminate barriers to entry and increase the competition in their industry, virtually every CEO will give a million reasons why a freer market does not make sense in their particular case. The insurance industry is no different.
When you examine specific measures that have been supported, or are being supported, by the insurance companies, there is a predictable pattern. First of all, they all advocate "compulsory" automobile insurance to insure plenty of customers. Secondly, they favor things like greater capital requirements, tighter regulation of rating, and innovative taxing schemes. However, all of these things are advocated and supported in the name of "protecting the public." We wouldn't want you to purchase insurance from a company that is not adequately capitalized!
If these companies truly believed that they were acting in the interest of their customers and the public at large, wouldn't they also believe that they would eventually write most of the business anyway? It tells you what they really believe.
Protection from Innovation
It seems to be the nature of things for big, old, established companies to also be fat, slow, and inefficient. If so, it leaves them vulnerable to quick-moving, market-responsive, hungrier companies. One way for companies to slow down their hungrier competitors is to become leaner, faster-moving, and more efficient themselves. However, a quicker, less-painful, and easier way is to work with their partners in the government.
Insurance companies are consistent proponents of tighter underwriting rules, stricter rating rules, and more specific definitions of coverage. These measures are advocated in the name of efficiency, but they result in very little room for innovation. The customer-responsive companies are not allowed to respond to the market because the rules do not allow it. Innovation still exists, but it is expensive to implement, and in constant danger of being regulated away.
Wasn't this category already mentioned on the government side of the ledger? Yes, the whole process legitimizes everyone's role. If a company is taxed, regulated, and legislated as part of the process and is still able to survive and prosper, then it must be doing a good job. "Mr. Customer, you can count on me. If I subject myself to the regulatory process, then you know your insurance dollars are safe with me."
The latest issue that demonstrates the true nature of the insurance/government partnership is terrorism. Yes, the industry suffered horrendous losses as a result of the events on September 11, 2001. Yes, the industry would go broke in a hurry if this became a regular thing. Yes, we should seek solutions to the problem.
But does that mean that the government should become an "insurer of last resort?" For the insurance industry (as always), the consensus answer is "yes." They jumped at the chance to solidify and enhance the partnership. By the time the process was completed, the final solution had terms that are protective of and beneficial to the insurance companies, and more costly for the consumer. In addition, all of the elements mentioned above (what the government gets and what the companies get) have been enhanced.
Obviously, the market is not capable of responding to such a monumental problem. Or is it? Maybe we should take a closer look at what has actually happened in the insurance marketplace on the issue of terrorism.
Terrorism is not an insurable risk by definition. The potential losses are not predictable, cannot be adequately contained, and are not of a nature where a proper price can be determined. A close look at standard policy language reveals (based on interpretation) that terrorism is not covered, nor was it ever intended to be covered, based on the War Risk Exclusion.
While the interpretation of that exclusion can be debated,5 it is clear that companies did not charge a premium for this coverage and did not contemplate that exposure in their ratemaking. Then why in the world would the industry step forward and pay upward of $30 billion in losses?
It all gets back to the partnership. Shortly after the attacks, President Bush, knowing that coverage was in question, asked the insurance industry to step forward and voluntarily provide coverage, in the name of patriotism. Once the first few companies committed themselves to covering the losses, the rest of the companies were forced to follow. (Imagine the public relations and legal problems you would face if you did not follow.) The unstated agreement is this: "Help me out by covering these losses and I'll help you out. I'll pass laws to make the government insurer of last resort so you won't have to worry about this in the future, and I'll do my part to support your business in the future."
But isn't it a good thing that President Bush boldly stepped forward to rescue people from their financial losses? If terrorism was allowed to be excluded from coverage, people would be left out in the cold with no losses being paid, and the consequences would be devastating. Really?
One of the most fascinating aspects of the September 11 disaster is the response from private organizations and individuals outside of the insurance business. Nearly two centuries ago, the French observer Alexis de Tocqueville remarked on the unique willingness of Americans to organize themselves to meet community needs.6 You can argue that this is a perfectly rational and appropriate way for this situation to be addressed, even if the insurance industry and the government were not involved. Does it really seem so far fetched that this kind of heinous act can be rectified (financially) through the voluntary efforts of good people, without government involvement?
Markets have a way of responding to any situation. But how could the voluntary efforts of Americans possibly come close to replacing the $30 billion in losses projected to be paid by the insurance industry? They may come closer than you realize.
According to a September 2002 report from the General Accounting Office (GAO), entitled Interim Report on the Response of Charities, a staggering $2.45 billion was raised by 34 large charities in response to the September 11th tragedy. The list of charities includes the American Red Cross Liberty Fund, The September 11th Fund, the Twin Towers Fund, the International Association of Firefighters, and the Salvation Army. However, this is a small sliver of the total charitable activities related to September 11.7
In the June 2002 edition of Ideas On Liberty magazine, Doug Bandow points out that, "Americans responded in a staggering variety of ways after September 11, creating special funds, hosting car washes, providing food, donating blood, and doing much more."8 There are literally thousand of organizations that have provided direct and indirect relief efforts (monetary and non-monetary). Countless churches and neighborhood groups coordinated efforts to raise money, food, clothing, etc.
Even the GAO report acknowledges that, "a precise tally of how much charitable aid was collected…may never be available given the difficulties in tracking information across multiple independent charitable organizations."9" And the donations are still rolling in, though at a slower pace. In addition, we have not even begun to tally the enormous efforts that have taken place outside the United States and throughout the world.
The following are a few examples among thousands of charitable efforts that are likely not counted in the statistics of recognized charities:
Over $1 million was raised for the Twin Towers Orphan Fund, which provides financial support for children of the victims of September 11.10
Institutional donors (corporations and foundations) contributed over $1 billion to various charities, according to the Philanthropy Journal.11
The German Cardiac Society donated $100,000 to the Fire Department of New York to replace an ambulance lost on September 11.12
Keefe, Bruyette & Woods, a New York-based investment banking firm, has raised more than $10 million to help support the families of the 67 former KBW employees that perished on September 11.12
Authors of the book 911: The Day America Cried will donate the proceeds of the book to the Todd M. Beamer Foundation.14
Merrill Lynch has established a $5 million scholarship fund to benefit students at three lower Manhattan high schools affected by the tragedies of September 11.15
America's Fund for Afghan Children has raised $9 million. This money was raised through American children who each donated $1 to help suffering Afghan children.16
How much has been raised in total? No one will ever know for sure. Based on what we do know, I believe a reasonable estimate is $10-20 billion. If this number is anywhere close to being accurate, it is compelling evidence of the power of voluntary response to a crisis. Could America rebuild from another terrorist attack if there was no insurance and no government money? I believe the evidence shows that it would.
What if our entire society was based on voluntaryism? Would there still be an insurance industry? What would it look like, and how closely would it resemble what we have today? How could the system work without a central authority to make sure that everyone is treated fairly?
No one knows for sure how things would look under voluntaryism, because it is based on spontaneous action that is not distorted by the presence and interference of government. However, we can make some educated guesses.
The first thing to understand (contrary to the statements in the Florida State University Law Review and to beliefs held by most Americans) is that regulation of insurance is not necessary. Yes, there is potential for large losses of income and assets if exposures are not properly covered. Yes, the business is complex. Yes, some companies will attempt to take advantage of their customers. Yes, it is a competitive business, and the possibility exists that some companies will go broke.
But the government cannot fix these problems.17 It can only make things worse, as it has. As usual, the new bureaucracy that has been created to provide terrorism coverage is enormous. The reporting requirements (both to the customer and to the government) are extremely onerous and costly. Worse, the coverage provided is not adequate to serve the intended purpose (other than as a "political" feel-good measure), nor does it address the basic underlying problem that the exposure is uninsurable, as my previous comments have made plain. Ironically, a large percentage of customers are choosing not to purchase terrorism coverage, which defeats the purpose of the entire program. If there were no coercive government, people would know that they must fend for themselves, in every respect. They would have the incentive to be better educated about various types of insurance, the services available, and the reputations of the various companies. Or, they would make sure they have an agent who has the knowledge they lack.
Some companies will take advantage of their customers in a voluntaryist society, as they do now. However, the consequences will be more direct and more severe. Better educated customers will spread the word more quickly about unethical practices, and the companies will not be able to hide behind a government license and government regulation, which give the customer a false sense of security.
In a voluntaryist society, there likely would be private insurance available to protect against insurance companies going bankrupt. Currently, there is no such insurance because the government guarantees the obligations of bankrupt insurance companies,18 then passes the cost along to solvent companies (and their customers). This creates perverse incentives, including the fact that the customer is taken completely off the hook in choosing a company with solid financials. No wonder the business is so volatile!
There would likely be a much higher level of innovation by the insurance industry in a voluntaryist society. Today everything is homogenized because government regulation is intended to "level the playing field." Remember that a critical component of the insurance/government partnership is to keep barriers to entry high, and to make life difficult for newer, smaller, market-responsive companies.
Without government protection, the insurance industry would likely be much more interested in preventing losses than in simply paying them and passing the costs back to the customer in the form of rate increases. It makes sense that there would be strong incentives for insurance companies and defense service agencies (private police) to form alliances in a voluntaryist society. How might that alliance manifest itself?
In their excellent book, The Market For Liberty, Morris and Linda Tannehill outline an extensive scenario of how insurance companies and defense service agencies might work together in what they call a "laissez-faire" society:
There are two main reasons for insurance companies' interest in the business of defense: 1–acts of aggressive violence result in expenses for insurance companies, and 2–the more secure and peaceful the society, the more value-production there will be, and the more value-production there is, the more things there will be that require insurance coverage, which means more insurance sales and more profits.
In a laissez-faire society, insurance companies would sell policies covering the insured against loss resulting from any type of coercion. Such policies would be popular for the same reason that fire and auto insurance are–they would provide a means of avoiding the financial disaster resulting from unexpected crises. Since insurance companies could not afford to insure poor risks at the same rates they charged their other customers, insurance policies would probably specify certain standard protective measures that the insured must take in order to buy the policy at the lowest rates–burglar alarms connected to the defense service company's office, for example.
Policies would also state that the insured must buy his protection from a defense agency that met the standards of the insurance company, to avoid having him hire an inefficient or fly-by-night defense agency at a cheap price while counting on his insurance to make up for any loss which their ineffectiveness caused him.
Because of the close connection between insurance and defense, some of the larger insurance companies would probably set up their own defense service agencies in order to offer their clients the convenience of buying all their protection needs in the same package. Other insurance companies would form close ties with one or more independent defense service agencies that they had found to be effective and reliable, and they would recommend these agencies to their customers.
As an added benefit, the powerful insurance companies, with their vast and varied resources and their vested interest in seeing values protected and aggressive violence held to a minimum, would act as a natural check upon the defense service agencies. This is an example of how the market, when left unhampered, constantly moves toward a situation of maximum order and productivity. The market has its own built-in balancing mechanism which automatically keeps it running smoothly with the best long-range results for every peaceful individual. Government is only so much sand in the gears.19
Insurance is potentially a dynamic and exciting business that provides much-needed services. In today's world, it has evolved into an inefficient and uncompetitive dinosaur. I believe the primary reason for the current state of affairs is the insurance/government partnership. Under a voluntaryist approach, I believe we would see broader coverages, better service, and significantly lower prices. Unfortunately, there does not appear to be much chance of this happening anytime soon.
1 Early insurance companies often did not understand the need for re-insurance. Many restricted their underwriting to the city or town where their headquarters were located. Unfortunately, this produced a heavy concentration of values, and it was not unusual for a single catastrophe (like the Chicago fire of 1871, or the San Francisco fire and earthquake of 1906) to bankrupt an insurance company. For more details on the "Historical Development of Insurance" see "Insurance," Volume 21 (Macropaedia), The New Encyclopedia Britannica" Chicago, 1992, 15th edition, p. 753. Also see Albert Loan, "Institutional Bases of the Spontaneous Order: Surety and Insurance," 7 Human Studies Review, No. 1 (Winter 1991/92), pp. 3, 17-24, available on the web at http://www.theihs.org/libertyguide/hsr/hsr.php/13.html. The parallel between the evolution of the early insurance industry and the early automobile manufacturing industry is very interesting. There were literally hundreds of small vehicle manufacturers in the early days of the industry. Only a handful eventually thrived and survived
2 Twentieth Century insurance companies have always eagerly embraced the belief that "excessive" competition is bad for the public (which obviously implies that it is bad for the existing insurance organizations, too).
3 Susan Randall, "Insurance Regulation in the United States: Regulatory Federalism and the National Association of Insurance Commissioners," 26 Florida State University Law Review (1999), pp. 625-699, at p. 627.
4 Bureaucrats in government agencies that regulate insurance companies are no different than their counterparts in other government programs and regulatory schemes. They all want to expand their control and conquest.
5 Every sentence of every insurance contract can and has been debated. The interpretation given here is the opinion of the author, though others have supported this position.
6 Doug Bandow, "The War on Charity," Ideas on Liberty, June 2002, p. 6.
7 Cynthia M. Fagnoni, Report to the Honorable Charles E. Grassley, September 11: Interim Report on the Response of Charities, General Accounting Office, September 2002, pp. 30-31.
8 Op. cit., Bandow.
9 Op. cit, Fagnoni, p. 29.
10 Business Editors, "Twin Towers Orphan Fund Seeks Additional Support, www.businesswire.com, December 26, 2001.
11 "9/11 Charity," PHILANTHROPY JOURNAL (March 14, 2002).
12 Business Editors/Health and Medical Writers, "New York City Mayor Guilani Accepts Gifts From Visiting Cardiologists," www.businesswire.com, December 14, 2001.
13 Business Editors, "Keefe, Bruyette & Woods to Donate September 24, 2002 Sales Commissions to KBW Family Fund," www.businesswire.com, September 18, 2002.
14 Business Editors, "Authors Contribute to Book Commemorating September 11," www.businesswire.com, September 9, 2002.
15 Business Editors, "Merrill Lynch Establishes $ 5 Million Scholarship Fund for Lower Manhattan High School Students, www.businesswire.com, September 6, 2002.
16 Walter Scott, "Personality Parade," Parade Magazine, August 11, 2002, p. 2.
17 Nor any other problems.
18 All 50 states and the District of Columbia have what are called Guaranty Funds, which essentially pay the losses of bankrupt insurance companies, then pass on the cost to the remaining solvent companies based on market share.
19 Morris and Linda Tannehill, from Chapter 8, "Protection of Life and Property," in their book The Market For Liberty (1970), pp. 85-87.