Multinational Monitor
in 1980 (10/80, page 7 to 9)
Who really bears
the insurer's risk ?
by Howard Clark,
J. Robert Hunter and Hans Dieter Meyer
Hans Dieter Meyer
is an insurance lawyer with a German association of insurance consumers (Zeller
Kreis). Robert Hunter was former Federal Insurance Administrator in HUD
and a casualty actuary. He is President of National Insurance Consumer
Organization. Howard Clark was a director of NICO and former chief
insurance commissioner of the State of South Carolina.
Though among the largest companies
in the world, insurance firms are also among the most misunderstood. This is no
accident. The insurance "industry" has carefully planted and nurtured a
widespread misconception of the true nature of insurance.
In fact, the insurance industry
does not produce at all; it is an insurance services industry, with companies
acting as bookkeepers for the redistribution of wealth among policyholders. By
presenting themselves as insurance producers and defending their presumed
prerogatives as such insurance
companies have misled, and mistreated, consumers around the world. From this
basic issue spring the problems of insurance redlining, the unavailability (or
unaffordability) of compulsory automobile or other essential insurance, unfair
discrimination in the underwriting, classification, and rating of risks, and the
failure or refusal of insurers to give proper benefit to policyholders for the
gains won on investments made with their income.
There is no doubt that insurance
is a big, and multinational, business. Risks and groups of risks are shunted
back and forth across the oceans through intricate reinsurance arrangements.
Major insurance holding companies such as INA, the American International Group
and the German-based Allianz Insurance Companies conduct their operations on a
worldwide basis.
The funds and assets controlled by
insurers are staggering. In the U.S. and Germany, about 10 per cent of all
disposable income is under the control of insurers. U.S. insurers possess assets
2.5 times greater than those of the oil and gas industry; fire and casualty
companies alone have assets nine times greater than the auto manufacturers. In
the most recent year for which figures are available, fire and casualty
companies were the second most profitable industry in the United States,
averaging a return on equity of 22.3 percent. The median U.S. profitability was
16.7 percent.
And so it goes around the world.
Allianz in Germany is also remarkably profitable. In March of this year (1980),
Allianz stock was valued at 724 DM by October it had jumped in value to 1,150
DM.
It has only been in the relatively
recent past that the ancient institution of insurance has been portrayed by the
insurance industry as a "risk business" in which the risks of economic loss
borne by the insured have been transferred to the insurers for a price - the
premium.
Insurers now contend that since
they assume large risks for policyholders, they are entitled to commensurately
large profits. The fallacy here is that there is no risk transferred to the
insurer. The individual risks of the policyholders are pooled through the
creation of a common fund; the risk is eliminated by redistribution through this
fund. Indeed, the only risk borne by an insurer is that their profits in one
year may not be as extravagant as they were in the previous year.
An often-made distinction between
insurance and gambling illustrates the difference between the industry-promoted
version of insurance and reality. Consider: gambling creates a risk that
formerly did not exist, while insurance eliminates a risk that formerly did
exist. This distinction is crucial. When insurers say they have taken on their
own shoulders the risk that the policyholders formerly assumed, they are saying
that the company is gambling that the policyholders will remain claim-free and
that the premium is a wager. If they win, needless to say, they believe they are
entitled to win big. And the insurers dictate the odds. Even so, the profits are
state guaranteed, because supervisory authorities have to care for the solvency
of the insurance firms. Thus, the premiums must be permanently set too high to
guarantee that even the final claimant could collect. Studies of the fire and
casualty business over the last 25 years indicate that the industry has never
lost even one dollar on a cash flow basis.
Insurance, then, consists simply
of a common fund established by those exposed to loss - a tool to eliminate
risk. The insurer only manages the common fund. This view of the common fund is
not new. As far back as 1825, a select committee of the British House of Commons
reported, "Whenever there is a contingency, the cheapest way of providing
against it is by uniting with others, so that each man may subject himself to a
small deprivation [premium] in order that no man may be subjected to a great
loss." So insurance is merely the redistribution or pooling of risk among
policyholders, not a business or an industry at all. Insurance does not produce
anything, as the economists who caculate the Gross National Product in both
Germany and the U.S. recognize.
The fact is that the sole service
performed by the insurance company is the management of the common fund on
behalf of the policyholders. It is only the expense of collecting premiums and
settling claims that is recognized in the GNP. In a $ 100 premium that divides
into $ 60 for the common fund and $ 40 for the insurers' overhead and profit,
only the $40 enters the GNP. The accounting for insurance in the GNP constitutes
nothing less tham a complete refutation of the insurers' contention that
insurance is a product and that the premium represents the price for that
product.
According to James H. Hunt, former
Insurance Commissioner for the State of Vermont, the industry's false claim of
ownership of the policyholders' money provides them with a powerful incentive to
unfairly minimize their losses. It is this urge, he says, that leads them to
redline - to deny insurance to millions of people, thereby forcing them to
obtain mandatory insurance (such as auto) through assigned risk plans which
offer poorer coverage and inferior service at higher premiums.
"The incentives provided by this
false view of insurance inevitably lead insurers to engage in competition for
'good books of business': groups of insureds with lower than average claim
expectancy," says Hunt. "The fallout from this selection competition is that
many good risks find themselves in the unwanted groups; the selection process
identifies these groups to an arbitrary fashion. It encourages competition
solely through selection of risks, which is harmful to the insurance consumer
and creates chaos in the insurance marketplace. It also shields the industry
from price and service competition on the expense part of the premium dollar,
where competition would be beneficial. Policyholders are reluctant to shop the
marketplace knowing they may be cancelled without cause. This freezes the
market."
Government insurance regulation
has solidified these practices. Regulators have concentrated on the adequacy of
premium dollars to meet potential losses. Far too little thought has been given
to the notion that the common fund belongs to the policyholders. Insurance
regulators should ponder the example set by the system of compulsory auto
insurance in Japan. There, for the purpose of establishing a nationwide risk
pool, all insurers must compute premiums by internally adding their expense and
profit margins to a government-approved price for the claims portion of the
premium that is applied to all companies. No profit or loss from the claims
portion of the premium accrues to insurers. Thus, competition occurs among
insurers only with respect to prices they charge for their services as well as
the quality of those services and their roles as managers of the common fund.
Insurers vie to service the whole market for insurance, not just that segment
they deem worthy of their attention. Since their profit comes not from
arbitrarily minimizing losses but from maximizing coverage; firms are motivated
to serve as many customers as possible.
The true nature and functon of
insurance ought to be exemplified by the non-profit mutual insurance companies
which are ostensibly owned by their policyholders. But the mutual insurers have
become creations of their managements, who in practice - though not in law - own
them. Mutuals now have become no less profit-oriented than the stock companies -
and no more responsible. During recent U.S Senate hearings on the mutuals,
attorney Gary Kreider testified: "I think this committee has found America's
forgotten investor, the mutual owner who contributes, but does not control, his
capital; who owns, but does not order, his enterprise; who provides but does not
participate in the profit and who, through it all, is left ignorant and impotent
by present law."
The supreme irony is that the
intense lobbying and propaganda efforts of the insurance industry which sustain
this regulatory protection are funded primarily by the policyholders themselves.
Of all the billions of marks, dollars, rupees, drachmas, and coins of all
nations supplied by the policyholders, only a pittance goes toward advancing
their interests - and that only in a handful of farsighted jurisdictions that
insist some small portion of premium dollars be devoted to the protection of
insurance buyers. In the state of New Jersey, for example, the Office of the
Public Advocate represents the public at insurance rate hearings with funds from
a tiny fee on insurance companies.
Where do insurance consumers go
from here? - The goal is clear: to work toward a legal separation of the claims
part of the premium from the service and profit part. Then, the forces of
competition will work to lower the costs of insurance services provided by the
managers of the common funds, rather than toward profit maximization through
selection competition.
This goal is obviously a long way
off. To begin consumers should seek consumer checkoffs, with the aim of gaining
at least as much funding for consumer representation before insurance regulatory
officials as the companies devote to lobbying these same officials through their
trade associations. Such checkoffs are now used by students in the U.S. and
other countries to form PlRGs, and Wisconsin utility consumers to fund a Citizen
Utility Board.
The insurance "industry" has
carefully planted and nurtured a widespread misconception of the true nature of
insurance.
Consumer groups should seek
from insurance companies at least as much funding for consumer representation
... as the companies devote to lobbying through trade associations.
Consumer groups should seek
checkoffs with the aim of gaining at least as much funding for consumer
representation ... as the companies devote to lobbying through trade
associations.
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