Dec 19 - Americans obtain their healthcare through insurance. That is unfortunate for an industry already freighted with reputational burdens. The valuable social role of insurance needs stauncher defenders, writes William Pitt.
In depression-era America, it was banks. The Barrow gang, led by Bonnie Parker and Clyde Barrow, became folk heroes to many in the early 1930s for their audacious (but also murderous) bank raids. In the 2020s, the popular bête noire may prove to be insurance companies, to judge from the shockingly complacent reaction of many Americans to the murder in New York of Brian Thompson, chief executive of the country’s largest health insurer, UnitedHealthcare. Luigi Mangione, the alleged killer, is well on his way to folk hero status.
Insurance companies come in widely varying forms, but public awareness of their differences is low. The entire industry in the US is therefore tainted by its association with health insurance and the much vilified role played by health insurers in restricting access to medical treatments. Tellingly, embedded insurance – typically an impulse purchase where first impressions are critical – is often pitched to consumers simply as “protection” rather than as insurance.
Kai-Uwe Schanz, co-founder of Purpose for Insurance, a Zurich-based consulting business, argues that the valuable social purpose of insurance has been under-communicated by the industry. Through his business, Schanz aims to promote the “intrinsic social purpose at the heart of the insurance business model”. He describes this as “sustaining modern economies by enabling households and businesses to prevent, withstand and recover from adversity while fostering savings and investments”.
Conveying this positive message can be an uphill struggle. Jerry Theodorou, director of the finance, insurance and trade policy program at R Street, a Washington, D.C.-based free market think tank, calls insurance “the industry everybody loves to hate”. To counter the negative publicity, he identifies three things that “the public and lawmakers should understand about the industry”.
The first, which is almost certainly unappreciated outside financial circles, is the key role played by insurers as investors in their home countries. In the US, insurers’ bond holdings are currently worth around $1.35 trillion. Through corporate bond purchases, insurers give American businesses capital to expand. And through municipal bond purchases, insurers are huge investors in the country’s infrastructure.
A perhaps better understood but still possibly underappreciated role of insurers is as what Theodorou calls “first responders” to adverse events, including what would otherwise be catastrophic losses. The US property casualty industry paid out $495 billion in net claims in 2023.
The third is the role of insurance as an essential lubricant for the American economy – and indeed for all developed economies. “Nothing moves without insurance – you can’t do a damn thing without insurance somehow lubricating the wheels.”
The insurance industry’s defenders have a good deal of ammunition. But its critics do too, and while some of the arguments in the industry’s favour are impersonal and a little abstract, many of the charges brought by its critics align with the day-to-day experience of policyholders. These include impenetrable policy language (notwithstanding the efforts of some insurers and regulators to encourage clearer communication) and opaque pricing. Compounding the offense, the sharply rising cost of insurance since the pandemic has been a major driver of broader inflation measures.
Underpinning all of this is the fact that the interests of most insurers and their policyholders are poorly aligned. With the important exception of mutuals, the insurance business model looks like a zero-sum game. If I, the policyholder, do well, my insurer must do badly, and vice versa. Interests do align around risk prevention, but this can be challenging terrain for insurers, requiring their policyholders to engage with them more than they would like to.
Even when property and casualty insurers are able to extricate themselves from this reputational morass, they often celebrate behaviours that threaten to suck them back in. The industry tends to admire insurance executives whose companies have performed well for shareholders as measured by combined ratios. In theory, a low combined ratio may derive from a very lean expense structure that enables a high proportion of premiums to be paid out in claims, but in practice, it rarely does. A few companies, such as the small-account E&S insurer Kinsale, have achieved both low expense ratios and low loss ratios, but many win the respect of their peers by achieving a less satisfactory outcome for the customer – a high expense ratio and a low loss ratio. Underwriters who are skilled at dodging bullets do not come cheap.
Efforts to improve the value of insurance by slashing expense ratios often under-deliver. The Future at Lloyd’s blueprint, published in 2019, sought to foster the market’s growth and prosperity by “significantly reducing costs.” Expenses have indeed come down, from 38.7 percent in 2019 to 34.4 percent by 2022, but this is well short of the improvement originally targeted.
Lloyd’s is not unique in failing to make major progress in reducing the cost of insurance. The expense ratio for the US property casualty insurance market as a whole fell from 27.2 percent in 2019 to 25 percent in 2023, but this was largely a reflection of sharply rising premium rates that helped insurers negotiate lower brokerage rates – andiIn dollar terms, broker remuneration has risen significantly. Taking a longer-term view, the industry’s expense ratio has scarcely budged since the 1970s. There is no expectation that recent modest declines reflect a secular trend.
Tough love
There is one other valuable service that insurers can provide for society, if they are allowed to do so. Insurers are in the business of pricing risk and can therefore send important market signals to deter risky behavior. Unfortunately, these signals can become obscured by well-meaning government efforts to protect people from the effects of their own decisions.
The issue was highlighted by a natural experiment that played out between the US state of Washington and the adjacent Canadian province of British Columbia. In 2020, a team of researchers from Western University, Wilfrid Laurier University and Aon sought to understand why the Canadians were far better insured against earthquakes, with more than 60 percent of Canadian homeowners buying coverage versus less than 14 percent of their Americans counterparts. They found that the main variable that could explain this was a higher expectation of government-sponsored disaster relief in Washington. This contrasted with a declaration by the government of British Columbia that “insurable damages in the private sector,” including earthquake damage, were ineligible for disaster relief.
When market mechanisms are disrupted, the misallocation of resources can sometimes be extreme. R Street’s Theodorou cites a Mississippi home worth $69,000 that flooded 34 times in 32 years and received, in aggregate, $663,000 from the taxpayer-funded National Flood Insurance Program.
As the frequency and severity of natural catastrophes increases, insurers’ role in highlighting risky behaviors (and in rewarding risk mitigation) is likely to become more important. Unfortunately, the likelihood that the public and lawmakers will thank them for it appears slim.
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