By Lars Powell, PhD
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.